Investment Portfolio Rebalancing

All investment portfolios should have an investment policy that includes asset allocation target percentages and allowable ranges around those targets.
All rebalancing methods involve marginal selling of out-performing assets and re-deploying into under-performing investments.
Age-old questions: When do we rebalance and how much?
- Q: How often should we rebalance?
  A: Typical approaches:
  “calendar method” (every month, quarter or year, etc.);
  “out-of-balance method” (when assets reach a fixed % from targets);
  “seat-of-pants method” (general sense of current market conditions).
- Q: Should we always rebalance to the targets?
  A: Yes, if you have no source of information to assist in a different decision;
  No, if you have a system to determine over and under weights.

What We Know About Financial Markets

Asset allocation has more impact on total return than any other aspect of investment policy.
A portfolio’s allocation to equities is the one choice that has the highest impact of any decision on investment results.
Bull Markets in equities are relatively steady, long lasting, and hence create an “upwardly biased” long term pattern.
Bear Markets are sudden and sharp, but comparatively brief.
Equity markets exhibit a “Central Tendency” that may be unpredictable in the short run,
but ‘revert’ to their mean of a 10 – 12% return per year over time.
Asset allocation shifts “at the edges” can have very significant impact over time.

By rebalancing based on the ‘calendar’, investors are unable to take advantage of longer running bull markets.
By rebalancing when an investment is ‘out of balance’, investors may lose their chance to take profits
or take advantage of extraordinary investment opportunities.
Dynamic Rebalancing uses markets cycles to tell us:
- When to Rebalance: use the momentum of the markets to capture larger returns as the market moves between bull and bear phases
- How much to Rebalance: use the strength of market moves to enhance the probability of achieving greater returns than “target-only” rebalancing
- Dynamic Rebalancing allows us to act (at the margins) on asset class-specific trend signals.

Research finding: Monthly measurement of trending is more effective than quarterly
Signal source: Generated from comparison of current market conditions with historical monthly return patterns
Low frequency: Designed to react only to “outlier signals” which deliver more effective action; most months, there are no changes.
Client-specific: Actions are constrained within an investment portfolio’s policy allocation target ranges.
Wealth accumulation result: System is designed to deliver improved efficiency “at the margins.”