Corrections Should Trigger Rebalancing

Abstract

We start from the provocative contention that if an investor did not rebalance earlier this year (2020), then that investor does not have an asset allocation policy. More specifically, that investor does not have a rebalancing policy to preserve their asset allocation. We then work backward from a presumption that a correction needs to induce a rebalancing trade and develop an algebraic solution for the width of the rebalancing range to ensure it does so. Across a range of reasonable assumptions, rebalancing ranges need to be tighter than traditional norms.

TOPICS: Statistical methods, portfolio construction, risk management

Key Findings

• • Wealth managers promising benefits from rebalancing need to deliver on that promise.

• • Corrections and bear markets, surprisingly, do not trigger traditional rebalancing ranges.

• • We develop a nontrivial analytical expression for rebalancing ranges that will trigger in a stock market correction and find they encourage much tighter rebalancing ranges.