The value of systematic rebalancing of portfolios to bring them back closer to strategic allocations has been questioned in new research by Morgan Stanley.The research, by Morgan Stanley’s Martin Leibowitz and Anthony Bova, indicates that portfolios which have not been rebalanced over a 10-year period, have either outperformed those which were rebalanced quarterly or closely matched them for returns.
The main reason for this is that the non-rebalanced portfolios capture the value in market momentum which tends to be lost through rebalancing according to a fixed time schedule.
The authors recommend, instead, that institutional and other investors have a program of “slow rebalancing”, which will avoid much of the dangers of not rebalancing in a bubble but at the same time capture some of the upside from momentum.
They say: “The no-rebalancing strategy has disadvantages in its greater volatility, its beta drift and its intrinsic ‘untidiness’. However, the surprising finding is the extent to which the non-rebalanced portfolio values either exceed or closely match those obtained with more standard rebalancing strategies.
“To the extent that these results can be generalised beyond this specific model, they are supportive of a more flexible and more strategic ‘slow balancing’ approach to realigning a fund’s structure over time.”
The study indicates that setting ranges, such that rebalancing occurs after the portfolio reaches a certain maximum or minimum value, has some benefit but this, too, is not significant compared with either non-rebalanced or quarterly rebalanced portfolios.
Slow balancing involves the investor deferring the rebalancing action to a time when it more closely coincides with general revisions in the policy portfolio.
This therefore requires a more active approach to the allocation by the investor, along the lines of a dynamic asset allocation – looking at a shorter time horizon than strategic asset allocation but longer than tactical asset allocation.
Details of the study can be viewed at www.morganstanley.com
