A.I.M. Users Bulletin Board

[ls7550]

Hi old_john

I'm wondering if there would be any advantage or disadvantage (other than perhaps the time required) in doing the AIM rebalancing on a monthly, quarterly or semi-annual basis?

UK 1958 to 2010 inclusive, each of UK house prices (excluding imputed rent benefit), UK main stock index (price only) and gold each returned around similar total returns. 2.5% real. Yearly rebalanced back to equal thirds weightings yielded 3.75% (putting aside you can’t really rebalance a third of house/home value yearly). That ‘rebalance benefit’ of 1.25% might be mentally attributed to the third gold, as though it paid a 3.75% dividend, not much less than the 4.5% average historic stock dividend yield or imputed rent benefits that are added on top of stock and house price only returns. So rebalancing added ‘trading gains’, or so it would seem. However if you didn’t rebalance you ended up with the same (similar) total return overall, but rather than ending with near thirds weightings in each you ended with significantly more in the asset(s) that had performed the best. Rebalancing reduced out of winners to add to laggards.

Rebalancing is very hit and miss. More often benefits are down to luck rather than skill. Primarily rebalancing is more a ‘risk reduction’ choice, as despite similar total returns the rebalanced approach tends to have the lower standard deviation in yearly returns and the likes of Sharpe Ratio in effect divide the total returns by the standard deviation, so a lower standard deviation yields a higher (better 'risk adjusted reward') Sharpe Ratio. But that’s only applicable if you consider volatility to be a risk. When you average in and out over many years volatility risk tends to wash.

So rebalancing works if the prior trend 'reverts' soon after having rebalanced, costs if the prior trend continues. Trading smaller amounts more often or larger amounts less often can also equally compare.

Only if you can find a method of consistently identifying good 'turning points' might rebalancing at particular points better the 'average' (non specific/fixed rebalance time points).

Rather than fixed intervals, some judgement might be applied if events at the time suggest that a turning point might be evident. If you get anywhere near turning points then having delayed trading until then will yield a better outcome than fixed interval/averaging. For gold for instance, a change from prior negative real yields towards or into positive real yields is inclined to see investors moving from gold into bonds. As might a transition from positive to negative real yields be inclined to see investors moving from bonds into gold. Fear/greed also has a tendency for flight to/from gold. With AIM providing a indicator of actual weightings to rebalance to, then if you did manage to get near historic turning points the rewards were considerable. 1980 for instance and it took just a single ounce of gold to buy a Dow stock index share, in 1999 a Dow index share bought 40 ounces of gold.

Clive