The Rebalancing That Wasn't
A client's IPS targets 60% equity / 40% bonds with a rebalancing band of ±5 percentage points. A strong equity run has pushed the portfolio to 69% equity. The adviser is reluctant to sell because "the momentum is strong" and instead directs new contributions to bonds, which will take 14 months at the current contribution rate to bring equity back inside the band. Meanwhile the client, who is 64 and plans to retire in three years, has not been told the portfolio is out of policy. The adviser's own compensation includes a trailing fee on assets, and equity funds in the lineup carry a higher fee than the bond funds.
1. Is the adviser's approach consistent with the IPS? What are the consequences of the drift?
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No. The band is ±5 points; 69% is 9 points over a 60% target - a clear breach. Directing contributions to bonds is a cash-flow rebalancing technique, which is legitimate only when it corrects the drift within a reasonable period. Fourteen months is not reasonable when the client is three years from retirement and the drift is already 4 points beyond the band.
Consequences of inaction:
- Risk is materially higher than the client agreed to. A 69/31 portfolio has a higher expected drawdown than 60/40. A 25% equity decline costs roughly 17% of the portfolio instead of 15% - and the client has only three years to recover before drawing on it.
- Sequence-of-returns risk is elevated: a drawdown near retirement is far more damaging than the same drawdown earlier.
- Governance failure. The IPS is a contract. Letting it drift because "momentum is strong" substitutes the adviser's market view for the client's risk parameters.
2. What conflicts and disclosure obligations are present, and what should the adviser do now?
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Conflicts:
- Trailing asset fee: Selling equities to buy bonds does not change total AUM, so the fee effect is small - but the adviser's reluctance to realize gains or reduce equity exposure can still be self-serving if it protects the fee base from outflows.
- Higher-fee equity funds: Keeping equity overweight keeps assets in higher-fee products. This is a conflict that must be disclosed and managed in the client's interest.
- Behavioral conflict: "Momentum" is a market call, not a client instruction. The adviser is substituting conviction for mandate.
Action:
- Rebalance now to target (or at minimum to the band edge), realizing that tax consequences should be checked - use tax-advantaged accounts first.
- Disclose to the client that the portfolio exceeded the band and why, and confirm the IPS still reflects their risk tolerance at 64.
- Document the conflict disclosure and the rationale for the trade.
- If the client genuinely wants a higher equity allocation, amend the IPS in writing - do not let the portfolio drift into a de facto new mandate.