Rebalancing and retirement asset management

Kim Kyung-rok

The author is an adviser at Optus Asset Management.

With the Kospi soaring from 2,500 to above 9,000 and shares of Samsung Electronics and SK hynix surging, rebalancing has become a much-discussed topic. Foreign investors sold large amounts of Samsung Electronics and SK hynix shares to rebalance their portfolios, contributing to a weaker won even as stock prices rose. What is rebalancing, why is it necessary and should individuals do it too?

Rebalancing means restoring balance. Suppose you have 100 million won ($72, 250) in assets, with 50 million won invested in the Kospi and 50 million won in a bond fund. Your stock-bond allocation is 50:50. That is the initial balance.

Now suppose the stock index rises by 200 percent. Your stock holdings are now worth 150 million won while the bond fund remains at 50 million won. The allocation has shifted to 75:25, breaking the original balance. To restore the 50:50 allocation, you would sell 50 million won in stocks and buy 50 million won in bonds. You would then have 100 million won in each, restoring the original balance.

There are several misconceptions about rebalancing.

First, people often ask, “Why rebalance if stocks will keep rising?” Rebalancing does not forecast asset prices. It is not market timing — selling because stocks have risen too far and seem likely to fall. It is a mechanical process of restoring balance.

Second, the purpose is to maintain an investor’s target asset allocation. In the example above, that means preserving the original 50:50 ratio between stocks and bonds.

Third, rebalancing follows predetermined rules. It can be done continuously, quarterly or semiannually. Another approach is to rebalance when an asset allocation moves beyond a specified range, such as when an asset’s weighting deviates from its target by more than a set percentage.

Rebalancing draws particular attention when asset prices soar or plunge. Consider the experience of David Swensen, who managed Yale University’s endowment. On Black Monday in October 1987, U.S. stocks plunged 22 percent in a single day. The collapse reduced the endowment’s equity weighting by more than 10 percentage points below its target.

Following his rebalancing principles, Swensen proposed increasing the endowment’s stock allocation. Investment committee members strongly objected. Swensen went to Yale’s president and explained his reasoning. The president backed the endowment manager.

Swensen later recalled that when he left the meeting, there were two pools of water on the table — sweat from his hands caused by the tension. The endowment ultimately profited as stocks recovered. But Swensen stressed that he had not predicted a market rebound. He had simply adhered to the principles of asset allocation.

Retirement pension funds overseas generally operate according to predetermined rules. Their returns can improve after stocks plunge and then recover because rebalancing leads them to buy shares during the downturn. The reverse applies when markets surge.

Korean retirement pensions, by contrast, often see individuals sell stocks after sharp declines and buy after steep rises. That is because individuals themselves adjust their asset allocation rather than relying on fixed rules or funds that automatically allocate assets.

Funds combining stocks and bonds are called balanced funds in English. When stock or bond prices move sharply, these funds automatically rebalance to maintain a set proportion between the two. Automatic rebalancing is one of their chief advantages. Unfortunately, the Korean term for such products, “mixed funds,” fails to convey the idea of restoring balance.

Individuals should also put rebalancing at the center of lifetime asset management, just as institutions do. This is particularly important for retirement and personal pension accounts, where asset allocation is fundamental.

Yet calculating appropriate weightings and maintaining them as markets change is difficult for individuals. Target-date funds and balanced funds can therefore be useful because they automatically handle asset allocation and rebalancing. Rather than trying to predict every turn in the market, retirement investors can benefit from a disciplined system that keeps their portfolios aligned with long-term goals.

For retirees, this discipline matters especially because investment decisions are not made in isolation. A portfolio must support spending over many years while limiting the danger that one market swing leaves it excessively concentrated in a single asset class. Rebalancing provides a framework for doing that without requiring investors to guess where markets will go next.

The key is not to react emotionally to headlines. A rule-based approach forces investors to trim assets that have grown beyond their intended weight and add to those that have fallen below it over time.