Optimal Portfolio Rebalancing Strategy : Evidence from Finnish Stocks

Abstract: Portfolio rebalancing is an established concept in portfolio management and investing generally. Assets within a portfolio have different return and risk prospects, and this inevitably leads them to drift away from their initial allocation weights overtime. Portfolio rebalancing is arguably the only method by which such assets can be reset to their initial weights, thus ensuring the portfolio reflects the risk appetite of the investor. Like many other concepts and practices in finance, portfolio rebalancing is a somewhat contentious topic, and many studies have sought to unearth optimal methods or strategies for rebalancing portfolios. This study also entered the fray of portfolio rebalancing research by analysing three broad strategies to determine which would be most optimal. The rebalancing strategies evaluated were: Calendar interval rebalancing (annually, half-yearly, quarterly, and monthly); threshold percentage trigger rebalancing (where a pre-established percentage is used to determine when rebalancing should be done); and a hybrid approach incorporating both the latter and the former. An equally weighted portfolio of 19 Finnish stocks from the Helsinki OMX25 index was used in the analysis, and the study period spanned May, 2000 to April, 2010. The results of the analysis showed that rebalancing provides rewards in terms of improved returns compared to not rebalancing at all. However, none of the 54 sub-strategies analysed under the three broad categories generated enough net of costs returns to be considered exceptionally optimal. Thus, rebalancing is best implemented when risk control and the psychological benefits associated with active portfolio management are desired. The above notwithstanding, arguably the most formidable returns were generated with a threshold of ±50-60% (implying that the portfolio is rebalanced when any asset weight drops to 2.10-2.63% or rises to 7.89-8.42%). This strategy set-off a relatively small number of rebalances, implying relatively low costs. It was also better than all other strategies, and far superior to choosing not to rebalance at all.