Portfolio Update – October and November 2021 – Strategic Rebalancing

It is December, and this is a period when most investors usually end up overseeing their portfolio allocations to start fresh in the coming year, and preforming periodical rebalancing.

While most just rebalance mechanically back to the original asset weights, we will be looking at whether rebalancing can be carried out in a way that improves returns and minimizes drawdowns when compared to both buy-and-hold strategies, as well as periodical rebalancing.

Many investors – both retail investors investing their personal wealth, and asset managers with millions in AUM – usually employ calendar rebalancing of a portfolio. This could be the quarterly rebalancing of a mutual fund, or that the retail investor sits down annually for a few hours during the Christmas holidays ahead of the new year to rebalance the portfolio.

Such periodical rebalancing is built on the fundament of mean reversion. It essentially sells the winners of the past period, and buys the losers. Over time, this is from where a rebalancing premium is captured when your portfolio consists of several uncorrelated assets. All Seasons Portfolios are a typical such portfolio that benefits from the rebalancing premium.

However, Man Group has researched strategic rebalancing techniques that could mitigate drawdowns through more bespoke methods for rebalancing. Their discussed techniques cover both the periodical rebalancings, as well as mid-period rebalancing when assets’ weights in portfolios deviate by more than a predetermined amount (rebalancing spans).

The retail investor should therefore consider the implications of trend and momentum both for periodical rebalancing and ad hoc rebalancing when using rebalancing spans, and implement a strategic rebalancing approach to further improve risk-adjusted return by minimizing drawdowns and thus the overall portfolio volatility, and potentially capture additional percentage points of return from trend.

In this post, we will be looking at a few ways of how to implement strategic rebalancing for your portfolio. I will also especially highlight the ways I have taken strategic rebalancing to heart in my All Seasons Portfolio.

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Portfolio Update – September 2021 – Why The 60/40 Portfolio Is Not Balanced

When it comes to the All Seasons Portfolio strategy, or any other risk parity strategy for that matter, one of the fundamental ingredients is how to allocate the capital between assets in the portfolio based on risk rather than capital.

Why this is important, or even why bother doing it at all, is a question I get quite often. I think therefore it is time to have a closer look at risk parity portfolio allocation principles. Here I mean the reason for why the allocation to the assets is based on their risk (volatility) rather than equal weight based on capital.

In this article, for a comprehensible description, we will be examining a simple two-asset portfolio to illustrate the importance of weighting assets based on risk rather than capital. For this example, I will be using a 60/40 Portfolio consisting of 60% stocks and 40% bonds, as this is popularly (and erroneously) considered as a “balanced portfolio”, and as this is a portfolio allocation strategy among both retail and institutional investors.

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Why Volatility Trend Tracking Matters And How To Optimize Your Portfolio Based On Inverse Volatility

As an investor who has adopted a risk parity mindset, and perhaps have implemented a portfolio following risk parity principles, such as the All Seasons Portfolio, I am sure you at least have a fundamental understanding of the importance of volatility.

In several articles, I have discussed why it is vital for retail investors in particular to decrease portfolio volatility, and using another term, to decrease portfolio risk. Otherwise, we risk not achieving our financial goals, if we would encounter bigger drawdowns than we can afford, or that we allocate too much capital to a single asset class such as stocks when such assets face a period of lagging returns.

So, if the question is "How can I reduce portfolio volatility", the answer is Risk Parity. Using these types of strategies and investing in several asset classes and allocating capital based on the asset classes' relative risk, you can significantly decrease the overall volatility of your portfolio, while still earning the risk premiums of each asset.

To facilitate management of risk of the different assets in a portfolio, and to implement a bottom-up risk parity approach for my stock exposure through an Inverse Volatility strategy, I have developed a Volatility Analyzer tool that also includes an Inverse Volatility Portfolio Optimizer. I first and foremost developed this for my own needs, which I will describe further below, but have found that it may be a useful resource also for you.

In this article, we expand on why tracking volatility is important and how it is easier to forecast than returns, as well as explain how my developed tool works.

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