Coffee Meets Investing
Asked on 07 Jul 2018
You may wish to note that "period-based" rebalancing is inferior and does not achieve the two main objectives of portfolio rebalancing, namely (i) risk management and (ii) the ability to lock in extra value-add returns. This is well-documented in David Swensen's book “Pioneering Portfolio Management”.
FYI, David Swensen was the first institutional investor in the world to adopt and formalise portfolio rebalancing as an investment technique. David Swensen is highly regarded in finance and investments globally.
Anyway, here's why "period-based" portfolio rebalancing is inferior and does not achieve the two main objectives. Imagine an investor who experiences the trade tension in 1Q 2018 and subsequently in Jun 2018 markets fully recovered back to where it was before the market correction.
(i) Risk management - the portfolio will be underweighted in Stocks and overweighted in Govt Bonds during the heat of the market correction in Feb 2018. This means the risk level of the portfolio will no longer be consistent with what the investor originally wanted and this inconsistent risk situation may well persist for some time (it did persisted till Mar 2018).
(ii) Ability to lock in extra value-add returns - An investor who adopt "period-based" rebalancing would have missed out the interim opportunity to sell Govt Bonds when it has appreciated in value and missed out the interim opportunity to buy Stocks when it has declined in value in Feb 2018 at the heat of the correction. Similarly, the same investor who would only spend 5 mins on 30 June 2018 would subsequently missed the opportunity to take profit when markets rebound and Stocks appreciate back to where it was.
In "threshold-based" rebalancing, which AutoWealth adopts, portfolios are analysed and monitored daily to identify material deviations from the original intended portfolio allocation weights. Whenever there is a material deviation, the portfolio is automatically rebalanced.
This means the portfolio risk is managed and consistent with what the investor originally wanted. This also means AutoWealth can capitalise on excessive day-to-day, short-term market volatility to lock in extra value-add returns for clients.
Statistically, portfolio rebalancing achieves 0.5% to 0.7% extra value-add returns on average over the long term, depending on which portfolio risk level the investor selects. We note that the 0.5% to 0.7% extra value-add returns adequately covers the fees we charge our clients. Therefore, it is much more cost-efficient to invest through AutoWealth as compared to DIY.