In Favor of 'Opportunistic Rebalancing'

by: Larry MacDonald

A new research study advocates “opportunistic rebalancing” of portfolios to enhance returns. Specifically, Gobind Daryanani’s paper, “Opportunistic Rebalancing: A New Paradigm for Wealth Managers” published in the January 2008 Journal of Financial Planning, concludes that a 20-per-cent threshold monitored every second week is the optimal rebalancing strategy.

If the target allocation for equities is, say, 60%, no adjustments are made until equities fall outside the threshold band of 48% to 72%. This does not happen often but when it does the biweekly monitoring of the portfolio is sure to catch it and lead to action. The end result is rebalancing that is infrequent but best in terms of capturing buy-low-and-sell-high opportunities, and thus augmenting returns.

According to Daryanani’s testing of rebalancing strategies on U.S. financial assets over the 1992-to-2004 period, “opportunistic rebalancing” outperformed the widely used five-per-cent threshold band (monitored annually or quarterly) by 0.25 to 0.30 basis points a year. The margin is trimmed after factoring in costs, taxes, and adjusting for volatility, but still positive.

Note that Daryanani does not adjust asset allocations back to their exact target but to the closest boundary in the tolerance band, defined as equal to 50% of the threshold band. Thus, in the example above if equities climbed past the 72% level, they would be cut back not to 60% but to 66% (effectively, the midpoint between the target and threshold band).