Rebalancing a mutual fund is the process of bringing the fund’s asset allocation back to its originally set proportions. This refers to the process of buying and selling certain holdings in a bid to re-adjust the weight of each component or asset class back to its original state. Changes occur due to alteration to investment strategy or risk-taking appetite, market fluctuations, etc.
Rebalancing involves periodical adjustment to the composition of a fund to maintain its desired asset allocation, by selling overperforming assets and buying underperforming ones to maintain the originally defined risk and return profile.
Many mutual funds are constructed with certain target allocations, such as a debt-equity mix of 60-40. Either component may exceed its defined allocation due to strategy or market changes, which eventually necessitate rebalancing of the fund. For example, if equity markets have substantially rallied, leading to equity overperformance as compared to debt components, a fund manager may need to sell or dispose of a certain portion of equities and readjust to a higher proportion of fixed-income securities to take the fund back its its original allocation.
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