Portfolio asset allocation drift* can pose a risk to advisors and their clients anytime interest rates change. "Drift" refers to the movement of allocations away from their target allocations, and it's often the advisor who is best situated to keep a close eye here on behalf of their clients. While some speculate the U.S. Federal Reserve Board may increase interest rates in December 2016, the Fed isn't the sole factor influencing rates.

Political and economic upheaval surrounding Brexit has prompted regional confusion about interest rates in Europe. In August, the Bank of England cut its benchmark interest rate to a historic low of 0.25% – its first rate change since 2009. Meanwhile, the European Central Bank may undertake additional economic stimulus measures in September. In the United States, the interest rate on 10-year Treasury notes, widely seen as a low-risk fixed-income investment, has fallen to all-time lows.

Given the buzz, it's easy to forget the effect interest rate changes and other unforeseen market events can have on portfolio allocations. While it is important to avoid knee-jerk reactions, understanding how these incidents can influence portfolios may help advisors minimize their damage.

Rebalancing implications

Small rate hikes over time could affect a portfolio as stock and bond markets react to changing market conditions. Evaluating asset allocation drift can help advisors avoid the risk of client portfolios becoming unbalanced. Here are three simple strategies to employ on behalf of your clients when drift sets in:

1. Consider taxes: In taxable accounts, rebalancing can trigger capital gains if equities rally in response to rate cuts. While an asset class may rise broadly, there could be opportunities to harvest losses in individual tax lots, which can help reduce clients' tax bills.

2. Implement asset allocation bands**: Rebalancing in accordance to an allocation band (or allocation range) rather than a strict asset allocation percentage can help achieve the objectives inherent in rebalancing while potentially avoiding a large tax consequence. If a client has a 50% equity allocation, an advisor can institute an allocation band of 45 to 55%. This could reduce the frequency of rebalancing. If equities grow beyond 55% and a portfolio rebalance is initiated, allocations may be rebalanced halfway back to target (52.5% rather than 50%).

3. Adhere to wash sale rules: Wash sale rules disqualify losses if an investor purchases what the IRS deems as "substantially identical" securities to replace the securities that were sold within 30 days.

There are ways to comply with wash sale rules while rebalancing to a target allocation. One approach is to purchase an exchange-traded fund as a proxy for the position that was sold, then consider repurchasing the sold position once the 30-day wash sale period expires. This may allow the client to maintain asset allocation within set bands.

By proactively developing a well-considered rebalancing plan with clients, advisors have an opportunity to reinforce their value proposition as a trusted resource and can strengthen existing client relationships for years to come.

The article Implementing a Systematic Rebalancing Program Can Pay Dividends provides more information on how advisors and their clients can gauge their portfolio balancing process throughout the year. Our Latest Insights page provides more information on markets and portfolio construction.


Rebalancing may have involve tax consequences.

Natixis Global Asset Management does not provide tax or legal advise. Please consult with a tax or legal professional prior to making any investment decisions.

* Allocation drift refers to differences in an account’s actual asset allocation compared to its target allocations. For example, a portfolio may start with a 50% allocation to equities and a 50% allocation to fixed income. Because these investments will inevitably perform differently over time, the actual allocations will begin to drift away from the starting or target weights. If several months down the road this same portfolio had actual allocations of 55% equities and 45% fixed income, there would be 5% allocation drift associated with each asset class.

** Allocation bands: A targeted range of asset distribution based on risk tolerance, time horizon and investment objectives. This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

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