Profiling Success: One Financial Advisor’s View On Asset Allocation & Rebalancing

Ron Vinder, a financial advisor at UBS Financial Services, says he’s doing just fine by managing client portfolios with a broad set of ETFs. Rebalancing the mix is a critical part of the strategy, he explains via Barron’s. “Whenever an asset class does well, that’s when individuals want to buy more. And they want to sell what’s doing poorly.” That’s all too typical, of course, which is part of the reason why the expected premium from rebalancing is so attractive. Indeed, if everyone was diversifying broadly and opportunistically rebalancing, the performance advantage would shrink considerably. But don’t worry: crowd behavior is resiliently rigid—even when the evidence for change is overwhelmingly persuasive.

Vinder reports that a portfolio comprised of a broad mix of assets classes via ETFs returned 72% (in absolute terms) during 2002-2011. That sounds about right, according to my numbers, although let’s update the record in annualized terms and provide more detail with my proprietary indices, namely, the suite of Global Market Index (GMI) benchmarks. GMI, as regular readers know, is a market-value weighted index of all the major asset classes, save for cash. I also calculate GMI in rebalanced (GMI.R) and equal-weight (GMI.E) versions. Each of these benchmarks, by the way, can be replicated with ETFs. Why should you care? Because GMI performs quite well over time. More precisely, it tends to earn average-to-above-average returns relative to the various efforts to beat it. Rebalancing GMI’s mix tends to earn a slightly higher premium, and equally weighting (and rebalancing) does even better. Forecast-free strategies, in short, can do a lot. You may want to do more, but the foundation is quite solid. What’s more, the advantages that accrue from a) diversifying across asset classes; and b) rebalancing the mix periodically holds up after adjusting for risk.
Consider, for instance, a basic profile of GMI indices relative to a traditional asset allocation benchmark: a 60%/40% portfolio of U.S. stocks and bonds (S&P 500 and Barclays Aggregate Bond Index). For the 10 years through the end of July 2012, GMI and its rebalanced and equally weighted versions posted a modest premium over the 60/40 strategy (see table below). Holding a wider pool of asset classes suffered a slightly higher volatility overall compared with the 60/40 benchmark, but the higher returns from rebalancing more than offset the slightly higher risk. In particular, GMI.R and GMI.E posted substantially higher risk-adjusted performances, as defined by the Sharpe ratio.
Is the advantage of combining asset allocation with rebalancing a surprise? No, or at least it shouldn’t be. As I discussed in my book— Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor–decades of financial research tell us that these two cornerstones of portfolio management are the building blocks of successful investing. Yes, the real-world results also look good when measured against actively managed asset allocation funds.
It’s encouraging to read that some advisors are on board with what should be standard practice for portfolio strategy. But let’s not fret too much. To the extent that most of the investment world disagrees, or can’t quite muster the discipline to diversify and rebalance effectively, on a timely basis, well, that leaves the rest of us with more opportunity to earn a bigger rebalancing bonus. There are no guarantees, of course, but it’s hard to argue with real-world track records and finance theory. There’s a finite supply of positive alpha available from managing a portfolio of broadly defined betas. But if history’s a guide, the limited supply is more than ample for the relative few who are willing and able to exploit the potential opportunity.

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