New research introduces a strategic rebalancing technique that could mitigate portfolio drawdowns.
A mechanical rebalancing strategy, such as a monthly or quarterly reallocation toward fixed portfolio weights, is an active strategy. Winning asset classes are sold, and losers are bought. During crises, when markets are often trending, this can lead to substantially larger drawdowns than a buy-and-hold strategy. This article shows that the negative convexity induced by rebalancing can be substantially mitigated, taking the popular 60-40 stock-bond portfolio as the use case. One alternative is an allocation to a trend-following strategy. The positive convexity of this overlay tends to counter the impact on drawdowns of the mechanical rebalancing strategy. The second alternative is called strategic rebalancing, which uses smart rebalancing timing based on trend-following signals – without a direct allocation to a trend-following strategy. For example, if the trend-following model suggests that stock markets are in a negative trend, rebalancing is delayed.