Case 080Rebalancing and driftWarm up
A client's Rs 2 crore portfolio has a 70/30 equity to debt target and has drifted to 78/22. What exactly must be sold and bought to get back, and are there cheaper ways to do it?
1The situation
Reshma Talwalkar's portfolio is worth Rs 2 crore. Her investment policy sets a target of 70% equity and 30% debt, with a tolerance band of five points either side. After a strong year for equity, the portfolio sits at 78% equity and 22% debt.
About 30% of the value of her equity units is unrealised gain. For tax, use an illustrative 12.5% on long-term equity gains above an illustrative annual exemption of Rs 1.25 lakh, and tell her to confirm current rules. She also mentions she will add Rs 10 lakh of fresh money next month.
2Your task
What trade restores the target, what would a band-edge rebalance or the fresh money change, and what does it cost in tax?
Quick check
How much equity must Reshma sell to return to 70/30 today?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Sell Rs 16 lakh of equity and buy Rs 16 lakh of debt. Equity is Rs 1.56 crore against a Rs 1.40 crore target, 8 points of Rs 2 crore. Two cheaper routes exist: rebalancing only to the 75% band edge needs Rs 6 lakh, and directing next month's Rs 10 lakh entirely to debt cuts the equity sale to Rs 9 lakh. The full trade realises about Rs 4.8 lakh of gain, roughly Rs 44,375 of illustrative tax.
Step 1How do you compute the trade without getting lost in percentages?
Turn every percentage into rupees against the whole portfolio. If a thali is meant to be 70% rice and 30% dal and it now has too much rice, you move rice by comparing grams, not percentages of the rice. Target equity is 70% of Rs 2 crore, Rs 1.40 crore; actual is Rs 1.56 crore; the difference, Rs 16 lakh, is the trade. Because the portfolio's total does not change when you swap equity for debt, the same Rs 16 lakh lifts debt from Rs 44 lakh to Rs 60 lakh, exactly 30%.
Step 2Does she have to go all the way back to 70%?
Not necessarily. Her policy has a tolerance bandThe range around a target weight inside which the portfolio is left alone; a trade is triggered only when a weight moves outside it. of five points, and 78% is three points outside it. A band-edge rebalance sells only enough to reach 75%, Rs 6 lakh, which halves the tax and trading cost but leaves her running above target until the next review. The full trade to 70% resets the risk properly. Either is defensible if it is written in the policy before the drift, not chosen afterwards.
Step 3How does the fresh Rs 10 lakh change the trade?
New money is the cheapest rebalancing tool there is, because buying the underweight asset costs no tax. With Rs 10 lakh added, the portfolio is Rs 2.10 crore and the equity target is Rs 1.47 crore. Putting all Rs 10 lakh into debt and selling only Rs 9 lakh of equity gets her to 70/30, against Rs 16 lakh of selling without the new money. Waiting a month for the cash is sensible if she is sure it is coming.
| Route | Equity sold, Rs lakh | Ends at | Gain realised, Rs lakh |
|---|---|---|---|
| Full rebalance to 70/30 | 16.0 | 70/30 | 4.8 |
| Band edge only | 6.0 | 75/25 | 1.8 |
| Rs 10 lakh fresh cash to debt, then sell | 9.0 | 70/30 | 2.7 |
Cost the full trade out loud. Rs 16 lakh of equity carries 30% gain, Rs 4.8 lakh; above an illustrative Rs 1.25 lakh exemption at an illustrative 12.5%, the tax is about Rs 44,375, roughly 0.2% of the portfolio, to bring risk back to what she signed up for. Tell her to confirm current rates and exemption before the trade, and sell the units with the smallest gains first.
Where candidates lose it
The frequent mistake is taking 8% of the equity instead of 8 points of the portfolio: Rs 12.5 lakh instead of Rs 16 lakh, which leaves her at about 71.8% and not on target.
The second is ignoring the fresh money. An interviewer who mentions a coming inflow wants to hear you use it to buy the underweight asset before you sell anything.
What the interviewer asks next
- Equity then falls 20%. Where is she, and what is the trade now?
- Would you rebalance on a calendar or on the band, and why?
- How would you rebalance if most of her equity sat in a single stock with a large gain?
Company names and figures are illustrative.