Robert Cannon (AIFA) Explains How To Rebalance Portfolios In a Post-Pandemic World

Updated on

In the post-pandemic world, there has been a residual effect on investors. Left in an unsure economy, extreme market volatility has left many unsure of how they will be moving forward and has eroded their confidence. Despite this uncertainty, many IPO plans were halted, yet IPOs by SPACs (special acquisition companies) have been on the rise since 2020 and according to Cannon, are here to stay saying, “SPACs are here for the next few years for sure. The momentum is evident because of the ease of the negotiation like an M&A deal.” He continues to elaborate saying that, “the price is easy to come up with and the payout structures are workout out between parties.”

Get The Full Ray Dalio Series in PDF

Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q4 2020 hedge fund letters, conferences and more

Rebalancing your Portfolios: How SPAC works

With no underlying business, in a SPAC, a group of investors will raise money for a shell company. When the SPAC goes public at generally $10 a share, it will then start seeking for a company to acquire. A deal will then be agreed upon when a target is found which is when the SPAC and the company pull in outside investors for a PIPE, also known as private investment in public equity.

Once the PIPE funds go onto the target company’s balance sheet in exchange for a big equity stake, the SPAC investors will then get stock in the acquired company and will then become the publicly-traded entity.

In IPO prospectuses there is a liability risk which gives SPACs a major advantage since they allow companies to provide forward-looking projections. It is also much quicker than the IPO, which requires spending months on end with bankers and lawyers to draft a prospectus, carry out a roadshow, educate the market, and build a book of institutional investors.

As the IPO process is being rejected by venture-backed tech companies with high-growth prospectus due to its own flaws, there is an undeniable mania in the SPAC boom. Instead, companies are getting acquainted with the idea of hitting the market in a way that would have been incomprehensible in 2020. Recent government statistics indicate that SPACs have raised more than $44 billion just this year so far for 144 deals, which is already equal to more than half the money raised during the entirety of last year.

How often should you rebalance your portfolio?

To approach portfolio rebalancing one should set asset targets since markets can change more in some time periods than others. A general rule of thumb is to rebalance when an asset allocation changes more than 5%, which refers to a certain subdivision of stocks changing from 15% of the portfolio to 20%. A key point Warren Buffett noted is what he likes to call “move like a sloth”, which essentially means having a constant aversion to activity, and consequently low portfolio turnover. The main lesson is to let your investment run for at least 5 years and teach yourself to navigate the turbulent bumps of price volatility with equanimity and your perception of the investment’s intrinsic value intact.

Should you rebalance portfolios in a down market?

Set a date once a year to check in if your portfolio is still on par with your goals, instead of randomly following the market - if not, then rebalance. Rebalancing entails selling winning investments in order to put increased funds into investments that have dropped, which is also known as buying low and selling high.

Would portfolio rebalancing actually improve returns?

Just to emphasize: rebalancing does not boost your long-term return. In actuality, to the extent rebalancing portfolios forces you to cut back on your stock holdings, and instead put more money into bonds, which reduces the return you are likely to earn over a long-term period, as stocks are prone to outperform bonds over an extended time.

What happens when you rebalance your portfolio?

Rebalancing portfolios mean realigning the weight of your various assets in order to maintain your desired asset allocation which is based on your risk appetite. This will mean that you will no longer have a 50/50 stock-to-bond asset allocation since those securities now make up almost 63% of your overall investments.

The Benefits of Rebalancing Portfolios

Although there might be a feeling of general apprehension from investors towards implementing portfolio rebalancing, there are ample benefits when the implementation is efficiently done. During the movement of assets rebalancing portfolios will protect investors from experiencing performance drag that may result from market movements. Notorious hedge fund manager and philanthropist Ray Dalio supports this notion and has suggested that rebalancing portfolios each year will help maintain the original asset allocation which indicates how much money you invest into certain asset classes in your portfolio, with the major ones being cash, bonds, and stocks.

Proper implementation of rebalancing portfolios may lead to the reduction of tracking error through policy-based exposure management and minimizing gaps in exposure may also lead to an increase in returns and simplification of asset movements in a way that will save time and money. By placing emphasis on exposure management, it will help investors to avoid deviation from policy targets that might increase tracking error - an increasingly important factor to consider in volatile markets.

About the contributors:

Robert Cannon is the CEO of Cannon Wealth Solutions. He was interviewed by Adriaan Brits on 19 February 2021 in his quest to compile a special report on how Chief Financial Officers deal with portfolios in a post-pandemic world.