Last updated: Sep-02-2014

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By Dave Paterson | Wednesday, September 03, 2014
Portfolio rebalancing is one of those topics that you hear a fair bit about, but it is quite often overlooked. That is unfortunate, because by following a disciplined rebalancing program, it is quite likely that you can increase your total return, while actually reducing your overall risk. Here’s how it works.

How does this happen? The simple explanation is that by following a portfolio rebalancing program, you are forcing yourself to sell high and buy low. Essentially, you take profits in those investments that have experienced significant gains and are potentially overvalued, while adding to those that are currently out of favour with other investors. This regular profit-taking reduces the amount invested in the overvalued investments, helping to reduce your downside when the selloff eventually occurs.

As an example, I set up a simulated portfolio with the same asset mix as the Couch Potato Portfolio we track in my Mutual Funds/ETFs Update newsletter: 40% FTSE TMX Canada Universe Bond Index; 30% S&P/TSX Composite Index; 15% S&P 500; and 15% MSCI EAFE Index. If I look at the returns for the 10 years ending December 31, a $10,000 investment would be worth $18,109, for an annualized gain of 5.07%. This return assumes that there was no rebalancing and that all distributions were reinvested.

These returns can be improved by following a simple rebalancing program. I looked at monthly, quarterly, semi-annual, and annual rebalancing. As shown in Table 1, in every case, the return was increased and the volatility, as measured by the standard deviation, was lowered. 


Next, instead of rebalancing the portfolio based on the calendar, I thought it might be interesting to use asset-mix ranges as the trigger for a rebalance. Using this methodology, a rebalance would take place when the portfolio weight of an investment was outside of a predetermined range, either to the upside or downside. For example, if I used a 10% range, a rebalance would occur when the weighting of the asset class was plus or minus 10% of the target weight. Looking at the bond allocation, a rebalance would happen if the portfolio weight was higher than 44% or less than 36%. I considered three ranges: 10%, 20% and 30%. 


Again, in every case, the portfolio returns were higher and the risk was lower than they were if no rebalancing had taken place. In fact, if you let the portfolio weights move as much as 30% away from the target allocation, the returns were substantially higher than if no rebalancing had taken place.

Intuitively this makes sense. By allowing a large enough range, the winners are allowed to run, producing higher gains for the portfolio. Once the range threshold is broken, the portfolio is rebalanced, with profits redeployed into the out-of-favour asset classes. The net result is a significantly higher return, both on an absolute and risk-adjusted basis.

Rebalancing in a registered account, such as an RRSP or a RRIF is fairly easy, since there are no tax considerations to worry about. In a non-registered account however, things can get a touch more complicated, because a rebalance may result in a realized capital gain.

In a non-registered account, one of the best ways to rebalance is through the addition of new money into the account. When you make a new investment, put the new money in the investments that are below their target weight. If you cannot rebalance with new funds, you will need to weigh the increased risk in your portfolio with the potential tax hit you may realize. If the tax burden is too high, a rebalance may not be worth it to you.

Bottom line

Portfolio rebalancing can be a great way to increase returns and lower portfolio risk. In a registered account, it is a simple and easy process, but the potential tax hit must be considered before rebalancing in a non-registered account. 

Dave Paterson, CFA, is the Director of Research, Investment Funds for D.A. Paterson Associates Inc., a consulting firm specializing in providing research and due diligence on a variety of investment products. He is also the publisher of Dave Paterson's Top Funds Report and Mutual Fund and ETF Update offering regular commentary and in-depth analysis of Canada’s top investment funds. He uses a unique analytical approach to identify funds with strong, risk-adjusted returns, and regularly publishes his insights and analyses in Fund Library.

Notes and Disclaimer

© 2014 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that a fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. This article is for information purposes only and is not intended as personalized investment advice.

By Patrick McKeough | Tuesday, September 02, 2014

BCE Inc. (TSX: BCE) has agreed to pay $3.95 billion in cash and stock for the 56% of Bell Aliant Inc. (TSX: BA) that it doesn’t already own. Bell Aliant shareholders have three options: cash; BCE shares; or a combination. What’s the best course of action?


By Fund Library News Wire | Friday, August 29, 2014

Canadian and U.S. stock markets closed higher on both the week and the month overall, as positive economic data boosted investor sentiment in North American markets, trumping growing geopolitical tensions in the Ukraine and the Middle East. In fact, the S&P 500 Composite Index passed a milestone, closing Friday at a record high 2,003.35, while Toronto’s S&P/TSX Composite Index finished the month with a record high close of 15,625.73.


By Robyn K. Thompson | Friday, August 29, 2014

Q – I’m married, with two young children, and my husband and I are both medical professionals with growing practices. I’ve seen first-hand what can happen to people who have insufficient medical insurance coverage. We have extended healthcare insurance through our professional practice, and I’m considering adding critical illness insurance as well. But I’ve read conflicting opinions about the value of this. Do you have any advice? – Angela T., Calgary, Alberta


By Susan Yates | Thursday, August 28, 2014

You’re going shopping for insurance. But whom do you buy from? The choices are bewildering. There are brokers and agents and underwriters. Some are “captive” employees of a single company, others are independent (sort of). Most have to be licensed by the government. But some don’t, and can still sell you an insurance policy. To help clear up some of the fog, and help you make the right choices, I’ve prepared this consumer’s buying guide to insurance product providers and their services.


More recent articles

By Dave Paterson | Wednesday, August 27, 2014
By Knowledge Bureau | Tuesday, August 26, 2014
By Gordon Pape | Monday, August 25, 2014
By Fund Library News Wire | Saturday, August 23, 2014
By Fund Library News Wire | Friday, August 22, 2014
By Robyn K. Thompson | Friday, August 22, 2014
By Samantha Prasad | Thursday, August 21, 2014
By Dave Paterson | Wednesday, August 20, 2014
By Doug Nelson | Tuesday, August 19, 2014
By Patrick McKeough | Monday, August 18, 2014
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