on Asset Allocation (AA)
There is controversy over rebalancing
One of the triggers of rebalancing is when one asset class has advanced substantially now representing a significant portion of an investor’s wealth. In order to bring the portfolio back to balance with the original model established, a portfolio manager may sell off the portion of the appreciated asset and reinvest the proceeds. The question and controversy then lies in the fact that if this asset class was doing so well and there hasn’t been any change in the company fundamentals that makes the investment less attractive, why sell it? For example a client that held $30 million in Berkshire Hathaway stock a number of years ago instead of selling to rebalance agreed that the fundamentals of the company was still strong enough to keep them and as of today her position is worth several hundred million dollars.
A wise advice over this issue may be to hold the position of selling off over-performing assets if an evaluation of the business operationally is done and it is concluded that the fundamentals are still attractive, the company still has a significant competitive advantage and the investor is comfortable with the large share of that asset allocation in the portfolio. If there is no willingness to commit to such criteria, it might be prudent to rebalance.
AA and Business Evaluation is needed
A lot of investors believe that simply diversifying assets as prescribed in the AA model will suffice discretion in the selection of individual investments. This is a dangerous mistake as quantitative and qualitative evaluation of the business being invested in is critical for progressive results. Investors may be well advised that if they are not capable of the abovementioned evaluation, they should make the request to their portfolio managers that they are only interested in defensively selected investments regardless of their age or wealth unless they can convince them that their position offers both safety of principal and the promise of above-average returns.
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