snowmman

Rebalancing Can Be Hazardous to Your Portfolio

If there's a free lunch, I think this author's data on opportunistic rebalancing is more plausible (taking advantage of volatility)

www.fpanet.org/journal...

and any argument against rebalancing because of costs in a taxable account also makes a lot of sense

www.fpanet.org/journal...


Also, it's an interesting question whether the state of a portfolio with a "let it ride strategy" would outperform one that used the same historic behaviors, but tuned with portfolio optimization software for some new risk/return profile. If it did, it kind of says the portfolio optimization software is broken.

Rebalancing Can Be Hazardous to Your Portfolio

Thanks for the replay Phil.
I suppose it's a little muddy since you're mixing historic info (correlations) with non-historic (monte-carlo).

In any case, here's an odd thought.

Assume I have two portfolios. One I decided on an
asset allocation 5 years ago and let it drift without
rebalancing till today. It has some defacto allocation now.

Another portfolio I want to start and allocate today.

Assume that the first portfolio is an ideal state in terms of
risk/return (it's drift has led to more risk, but more return,
but I want that).

And then I want the second portfolio to have the same
predicted risk/return. So I allocate exactly like the state
of the first portfolio.

Take that to the limit, and it says that the optimal risk/return
decision, is made by using a portfolio decision that was
made in the past, and allowed to drift to "some state" today.

That's basically saying the optimal risk/return decision is
made with historic data.

Right?

Isn't this just portfolio optimization using historic data
(and the appropriate software)

It basically is saying you can drift to a different risk/return
point? If so, shouldn't we just design the portfolio with
the higher predicted risk in the first place?

Or is the short term historic data more important. We can
still design using short term data, though.

see what I'm thinking?

-s

Rebalancing Can Be Hazardous to Your Portfolio

"We looked at 10,000 Monte Carlo simulations involving complex, seven-asset-class portfolios."

well, isn't that the problem? Assuming you did normal distribution
with correlations of 0 between asset classes? So you're modelling something that doesn't match asset class behavior historically?

Why didn't you use an analytic or historical model?

see
www.fpanet.org/journal...
for detailed critique of monte carlo simulations.

I haven't given it much thought, but assuming returns are
symmetrically distributed, normal, around a mean, with
no correlation, then yeah, it doesn't make sense to do anything,
because just waiting will get you your normal distribution
for each asset. But that's not what our asset classes do.

Isn't this just a bad experiment?