Abstract
After diversification, periodic portfolio rebalancing has become one of the most widely practiced methods for reducing portfolio risk and enhancing returns. Most of the rebalancing strategies found in the literature are generally regarded as contrarian approaches to rebalancing. A recent article proposed a rebalancing approach that incorporates a momentum approach to rebalancing. The momentum approach had a better risk adjusted return than either the traditional approach or a Buy-and-Hold approach. This article identifies an improvement to the momentum approach and then examines the impact of transactions costs and taxes on the portfolio performance of four active rebalancing approaches.
Highlights
The traditional 60 stock/40 bond portfolio allocation has evolved into a wide range of different approaches with numerous asset classes for both the equity side and the bond side
The goal of rebalancing is to take some of the excess returns from the positive deviations before they return to their long-term trend and put the gains in the asset classes with negative deviations before they return to their long-term trend in a positive manner
By examining the transaction costs and tax implications, this paper demonstrates that the more diversified momentum strategy performs better, in actual practice, than any of the contrarian approaches found in the literature and the original momentum approach (Mattei and Mattei 2016)
Summary
The traditional 60 stock/40 bond portfolio allocation has evolved into a wide range of different approaches with numerous asset classes for both the equity side and the bond side. They focused on a 60/40 stock/bond split They compared three different classes of rebalancing to the Buy-and-Hold strategy based on the theoretical foundations of the Perold and Sharpe research. Dichtl et al provide simulation evidence that all rebalancing strategies (periodic, threshold and range rebalancing with yearly, quarterly and monthly trading intervals) significantly outperform Buy-and-Hold for all countries and for all investment horizons (5- and 10-year) They found that while rebalancing on average provides value added to the investor, their results suggest that the choice of a specific rebalancing strategy is of only minor importance. Unlike the Miccolis and Goodman use of momentum, Mattei and Mattei (2016) wondered if there was a rebalancing strategy based on a momentum rule that does not buy the weakest performing asset classes as opposed to a contrarian approach where the winning asset classes are sold and the proceeds used to purchase the weaker performing asset classes. By examining the transaction costs and tax implications, this paper demonstrates that the more diversified momentum strategy performs better, in actual practice, than any of the contrarian approaches found in the literature and the original momentum approach (Mattei and Mattei 2016)
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