Rebalancing and Returns

and bonds. Maintaining an asset allocation policy that is suitable for the investor’s unique investment needs and risk tolerance requires periodic rebalancing. Left un-checked, any multi-asset class portfolio will drift from its target allocations as some classes outperform others. Over time, a non-rebalanced portfolio will tend to become concentrated in higher-return assets, exposing the investor to a very different risk and return profile than that of the intended allocation. Though the primary motivation for rebalancing is to control risks, there have been a number of recent studies that look at the relation between rebalancing and returns. One way rebalancing may impact returns is through the amount of drift allowed before the portfolio is rebalanced. Since expected returns are a function of the current allocation, any change in weights, due to rebalancing or drift, will have an impact on expected returns. A rebalancing strategy that tolerates a greater amount of drift will typically have higher expected returns and be exposed to greater risk compared to rebalancing strategies that allow less drift. Rebalancing strategies may also differ in the amount of costly trading involved. Th