Posts filed under “Investing”
Source: Capital Spectator
The most perplexing thing I read this week was an odd column by Paul Merriman at MarketWatch, “Why Rebalancing Could Be a Huge Mistake.” He makes the counterintuitive claim that portfolio rebalancing doesn’t really work: “Conventional wisdom holds that regular rebalancing is a sound practice to control investing risk. But I’ve concluded that some of that conventional wisdom is wrong.”
I dismissed Merriman’s claim offhand because what he described was not true asset class rebalancing. He was looking within the same asset class — U.S. equities — and subdividing them into four market cap weighted, style-based subgroups: large-cap, small-cap, large-cap value and small-cap value stocks.
His conclusion that rebalancing among these four didn’t work was a bit disingenuous. If you went on an all-Chicago-deep-dish-pizza diet and didn’t lose any weight, you wouldn’t exactly be justified in declaring that diets don’t work. But that is functionally the equivalent of Merriman’s critique of intra-U.S.equity rebalance.
But rather than rely on my own insights into rebalancing, I tracked down two experts who have studied rebalancing for years. Their criticism was much stronger than my own.
Robert Arnott runs Research Affiliates, where he helped craft the idea of fundamental (as opposed to market cap weighted) indices. RAFI, as the firm is known, generates returns through a combination of smart beta and asset allocation strategies.
Arnott critiques Merriman’s rebalancing claim as a “flimsy and meaningless straw man.” He shows through a series of examples what occurs if you chose not to rebalance a portfolio: The investor loses the benefits of diversification, as the portfolio over time morphs into a riskier, 99 percent stocks, mostly small-cap value fund.
The obvious risk (at least to me) with such a portfolio drift is the behavior of its holders. Any un-rebalanced portfolio eventually would become a gnarly mass of volatility and drawdowns. Imagine what that does to the psyche of the investor saving for retirement. It invites bad behavior and poor decision-making. Meanwhile, a diversified portfolio will have different sectors doing better or worse each year, producing more stable returns.
James Picerno takes a different critical approach to reach a somewhat similar conclusion. He starts with the caveat that the “optimal rebalancing strategy” is unknown in advance. Instead, it is designed specifically because we never know what the future holds. Rebalancing what is essentially an all equity portfolio of using only U.S. equities is not the same as rebalancing a broad asset allocation model. We should not expect “an equities-only portfolio” to have the same results via rebalancing than what we can achieve via a regularly rebalanced multi-asset-class strategy
We may not know in advance the precise improvements rebalancing produces over time, but we do know they are substantial. The alternative is a massive drift from one’s original asset weighting.
Any asset allocator who is comfortable with what will eventually become all equity portfolio should skip rebalancing. The rest of us continue to take advantage of what may be the only free lunch on Wall Street.
Robert Arnott is Chairman ＆ Chief Executive Officer of Research Affiliates, a global leader in smart beta and asset allocation strategies, and one of the originators of fundamental (as opposed to market cap weighted). His models now drive over $100 billion in assets in various funds, and an additional $75 billion at PIMCO. ~~~ …Read More
How often do you make a decision to sell something for a giant gain? Quite a few times across the arc of a career, if you are a half-decent investor. But how often is that sell decision a terrible mistake? Today, I want to tell the tale of Warren Buffett’s bungled profit-taking in Exxon. We…Read More
Tapering or Tightening? David R. Kotok Cumberland Advisors, November 17, 2013 Janet Yellen did well in her Senate hearing. Markets have settled on the notion that Federal Reserve policy is not going to lurch abruptly in a new and surprising direction. The results are to (1) shrink risk premia, (2) add to the…Read More
Twice a year, S&P releases a “SPIVA Scorecard” – a report comparing the performance of Active Managers versus three passive indices. The S&P 500 large caps, S&P MidCap 400, and S&P SmallCap 600 are pitted against the median returns of active managers. In the most recent report, the trailing 12 months returns for these indices…Read More
My Sunday Washington Post Business Section column is out. This morning, we look at the best ways to Use the News. As I noted last time out, its helpful to reduce your noise levels when it comes to investing. This go round the focus on getting more signal. For a change, I am…Read More
Source: BlackRock It seems that everywhere I go over the past few weeks, I bump into some form of bubble chatter. Mom and pop are returning to equities means it’s a bubble, all the new stock and bond issuance is a bubble and, of course, the Twitter initial public offering indicates we are deeply…Read More
This was written by Kris Venne, the Certified Financial Planner in our Asset Management group: Its 3:35pm on a Wed., your phone rings – it is your “advisor” over at MerFargonley. Conspicuously its pretty close to month end, say March 24th. “Hey Mike! Hows it going? How’s Sandy (your wife)? How about little Mikey?”…Read More
Crisis Chronicles: The South Sea Bubble of 1720—Repackaging Debt and the Current Reach for Yield James Narron and David Skeie http://libertystreeteconomics.newyorkfed.org/2013/11/crisis-chronicles-the-south-sea-bubble-of-1720repackaging-debt-and-the-current-reach-for-yield.html In 1720, the South Sea Company offered to pay the British government for the right to buy the national debt from debtholders in exchange for shares backed by dividends to be paid from the…Read More
November 2013 Forward Markets: Macro Strategy Review Macro Factors and Their Impact on Monetary Policy, The Economy and Financial Markets Global Economy – Better, But Not Good One of the investment themes gaining traction in recent months is the global synchronized growth story. Those who are bullish on equity markets for the remainder of 2013…Read More