13 Rebalancing: Tracking a target portfolio

 

This chapter covers

  • Rebalancing portfolios with defined target weights, and the pitfalls of not rebalancing
  • Simple rebalancing rules based on fixed time schedules or deviation thresholds
  • Optimization-based rebalancing incorporating transaction costs and taxes

Over time, a portfolio may naturally drift away from its target weights due to differing changes in asset prices. Rebalancing refers to the process of periodically correcting the drift to bring the portfolio closer to its target weights. In this chapter, we’ll show why rebalancing is important and cover various methods for rebalancing, starting with the simplest and ending with the most sophisticated.

13.1 Rebalancing basics

Earlier chapters have discussed ways of constructing portfolios that are “optimal” in some sense. They optimized an objective function—for example, maximum expected return or minimum tracking error—with some constraints on the portfolio weights.

13.1.1 The need for rebalancing

13.1.2 Downsides of rebalancing

13.1.3 Dividends and deposits

13.2 Simple rebalancing strategies

13.2.1 Fixed-interval rebalancing

13.2.2 Threshold-based rebalancing

13.2.3 Other considerations

13.2.4 Final thoughts

13.3 Optimizing rebalancing

13.3.1 Variables

13.3.2 Inputs

13.3.3 Formulating the problem

13.3.4 Running an example

13.4 Comparing rebalancing approaches

13.4.1 Implementing rebalancers

13.4.2 Building the backtester

Summary