A defined benefit pension plan, with a long-term liability profile, has a target asset allocation of 50% Canadian Equities, 30% Global Equities, and 20% Canadian Fixed Income. Following a period of strong equity market performance, the current allocation stands at 60% Canadian Equities, 35% Global Equities, and 5% Canadian Fixed Income. The plan has minimum return requirements due to its liabilities. What is the primary reason for rebalancing this portfolio?

Question: A defined benefit pension plan, with a long-term liability profile, has a target asset allocation of 50% Canadian Equities, 30% Global Equities, and 20% Canadian Fixed Income. Following a period of strong equity market performance, the current allocation stands at 60% Canadian Equities, 35% Global Equities, and 5% Canadian Fixed Income. The plan has minimum return requirements due to its liabilities. What is the primary reason for rebalancing this portfolio?

Answer options:

• To maximize short-term capital gains by selling appreciated assets. ✅ To align the portfolio with the plan's long-term risk and return objectives as specified in its investment policy, especially regarding liability matching.
• To exploit momentum by further investing in outperforming asset classes.
• To reduce transaction costs by minimizing trading activity.

Correct answer: To align the portfolio with the plan's long-term risk and return objectives as specified in its investment policy, especially regarding liability matching.

Explanation: The primary goal of rebalancing for a defined benefit pension plan is to ensure the asset allocation remains aligned with its long-term risk and return objectives, which are intrinsically linked to its liability structure. Drift from target allocation can expose the plan to unintended risks or jeopardize its ability to meet future obligations.