Information contained in this area of the Website is published solely for general informative purposes and intended only for United States and Canadian institutional investors, consultants, financial advisers, and other intermediaries who are who are knowledgeable and experienced in the financial services market and in investment products of this nature. If you are a retail, individual investor or non-ultra-high net worth individual then please leave this website immediately. The information is not authorized for use in a jurisdiction where distribution is not authorized and is not intended for distribution to retail clients, the general public or retail investors. If you choose to access this Website from locations outside of the United States or Canada, you do so at your own initiative and risk, and are responsible for compliance with all applicable laws.
U.S. Institutional Investors: By accessing this site you confirm that you are an U.S. Institutional Investor, you agree not to forward or make the contents of this site available to any person who is not an U.S. Institutional Investor, and you agree to be subject to intechinvestments.com terms of use.
Canadian Institutional Investors: By accessing this site you confirm that you are a “permitted client” as defined in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations of the Canadian Securities Administrators, you agree not to forward or make the contents of this site available to any person who is not a “permitted client”, and you agree to be subject to intechinvestments.com terms of use. The information on this Website is for informational purposes only and does not constitute (i) an offer for products or services or (ii) the provision of investment advice of any kind, tailored or otherwise. The information on this Website should also not be construed as an offer to sell or a solicitation of an offer to buy to any persons who are prohibited from receiving such information under the laws applicable to their place of citizenship, domicile or residence. Intech Investment Management LLC (“Intech”) does not have any funds that offer securities under a simplified prospectus for general offer or sale within Canada. No securities regulatory authority in Canada has reviewed or in any way passed upon this website or the merits of any investment available, and any representation to the contrary is an offense. Intech is registered with the United States Securities & Exchange Commission under the Investment Advisers Act of 1940. Intech is a subsidiary of Janus Henderson Group plc, and is affiliated with its subsidiaries and affiliates.
Decline - Redirect me to janushenderson.com
Topics: Portfolio Construction, Blog
Portfolio growth is more than just the weighted compound returns of its underlying stocks. There is also the additional return contribution from the diversification benefit a portfolio experiences through consistent rebalancing, based on the weights, volatilities and correlations of the stocks it holds. As we mentioned in our previous blog, we call this added return potential the excess growth rate.
But the degree to which investors successfully tap into it depends on their rebalancing approach. Their approach ultimately determines the potential rebalancing premium.
The figure below illustrates how a realized rebalancing premium may help add to long-term portfolio returns. This example shows the cumulative excess returns of an equal-weighted S&P 500 portfolio, rebalanced quarterly, compared to the traditional market-capitalization weighted version of the index, which follows a buy-and-hold construction that is not regularly rebalanced.
Investors should consider three inputs that can considerably affect the degree of rebalancing premium that may be potentially captured:
1) What are the individual stock weights the portfolio is rebalancing back to? We use an equal-weighted portfolio in our example as a simple way to illustrate the potential additive effects of the excess growth rate. Further optimizing a portfolio’s individual holdings, in terms of weighting size, how those weightings are determined and even number of securities, can have a significant impact on the return contributions from both the weighted compound returns of the underlying stocks and also the potential size of the excess growth rate.
2) What are the relative stock volatilities and correlations across portfolio holdings? Stochastic Portfolio Theory demonstrates that the excess growth rate depends only on stock weights, volatilities and correlations. Higher volatility and lower correlations among stocks potentially offer a higher excess growth rate (though notably not necessarily a higher overall return). Excess growth rates have been trending lower in U.S. markets over the past several years, which is unsurprising given that broad cross-sectional stock volatility has likewise declined. This dynamic has historically been cyclical in nature. There have been other periods where the market’s excess growth rate has been similarly low and subsequently rebounded—often sharply and suddenly, taking many investors by surprise. Further, while the potential benefits of the excess growth rate are usually greatest during periods of higher relative volatility, they are still available to some degree in all periods.
3) What is the rebalancing frequency? Rebalancing frequency also plays a critical role in the size of the excess growth rate potentially captured. Its potential additive effects have tended to increase with frequency, as shown in the next chart, which again uses a simple example comparing the excess returns of equal-weighted S&P 500 portfolios rebalanced at various frequencies. This is because there is less volatility capture as rebalancing becomes less frequent. Of course, it is important to balance any potential rebalancing premium with managing trading costs efficiently, where the potential reward from rebalancing does not exceed the cost of the trades required to implement.
Systematic rebalancing can offer significant added return potential over time, though the magnitude can vary depending on a number of factors, some within investors’ control and some not.
See What a More Sophisticated Approach Looks Like
We’ve covered some of the theoretical underpinnings of how diversification and rebalancing can be an alpha source, even in a simple implementation. But what if you optimized it? Learn more in our latest paper, “Does Rebalancing Still Make Sense?”
The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or other reasons. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Hypothetical performance results presented are for illustrative purposes only. Hypothetical performance is not real and has many inherent limitations. It does not reflect the results or risks associated with actual trading or the actual performance of any portfolio and has been prepared with the benefit of hindsight. Therefore, there is no guarantee that an actual portfolio would have achieved the results shown. In fact, there will be differences between hypothetical and actual results. No investor should assume that future performance will be profitable, or equal to the results shown. Hypothetical results do not reflect the deduction of advisory fees and other expenses incurred in the management of a portfolio.
Sign up today to receive the latest Intech® content in your inbox.
2021 Intech ©. All rights reserved.
The views presented are as of the date published. They are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security or market sector. No forecasts can be guaranteed. The opinions and examples are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties with regards to the results obtained from its use. It is not intended to indicate or imply in any manner that any illustration/example mentioned is now or was ever held in any Intech portfolio, or that current or past results are indicative of future profitability or expectations. As with all investments, there are inherent risks to be considered.