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.
- Q: How often should we rebalance?
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.
Why Dynamic Rebalancing?
- 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.
How Dynamic Rebalancing Works
- 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.”