Maximizing rebalancing effect - Volatility based dynamic rebalancing

[yiugn]

I happened to find this document, which is about maximizing rebalancing gain by volatility based dynamic rebalancing method, not by conventional periodic rebalancing.

http://www.macquarieprivatewealth.ca/da ... rected.pdf

However, I could not find any specific method to implement this approach, the only clue I could find was 'based on 60 day trailing volatility'

I think this approach is very logical and reasonable and I'd like to apply to my actual trading.

Do you have any idea on this approach?

[craigr]

Welcome to the forum. Thanks for posting.

I read through the paper and I guess my response is the same as always:

1) It doesn't include transaction fees and this kind of trading will be expensive.

2) It doesn't explain why past volatility would necessarily need to relate to returns going forward in any meaningful way.

3) In a taxable account this trading would also be expensive.

4) It is using hindsight analysis to predict the future.

So this is probably the wrong place to ask for whether it is a good idea, because I just don't think market timing works. Investors are better off buying assets, holding them, and rebalancing as necessary. I've never once seen a market timing system work as well going forward as the data showed it worked in the past. And I can't say I've ever come across anyone that has consistently captured these excess market returns either once all the costs are factored in.

[clacy]

OP, thanks for sharing that paper.

Craigr, why do you refer to this rebalancing strategy as "market timing" yet you advocate using rebalancing bands, correct?

I agree that certainly more frequent rebalancing COULD affect taxes and transaction costs depending on whether one is using a taxable or tax privileged account. Fees could be an issue but if you're using TDameritrade, VBS, Scottrade, etc, it probably wouldn't be a significant change.

[craigr]

OP, thanks for sharing that paper.

Craigr, why do you refer to this rebalancing strategy as "market timing" yet you advocate using rebalancing bands, correct?

I agree that certainly more frequent rebalancing COULD affect taxes and transaction costs depending on whether one is using a taxable or tax privileged account. Fees could be an issue but if you're using TDameritrade, VBS, Scottrade, etc, it probably wouldn't be a significant change.

The bands are just kind of neutral. They aren't trying to predict momentum, etc. like volatility metrics are doing or moving averages, etc. They just say "Hey this has gotten too high for whatever reason. You should sell down to control risk."

There's not voodoo involved.

Doing lots of transactions is only good for the broker and money managers over time. Individual investors are just not likely to see the benefits.

Why take something that is simple, reliable and proven (rebalancing bands and the PermPort) and go mucking around with market timing?

And again if these strategies were so reliable, why aren't the people running them billionaires already?

So my cynicism remains. Market timing is a bad strategy in all of its flavors.

[clacy]

"Hey this has gotten too high for whatever reason. You should sell down to control risk."

The same could be said for any rebalance strategy.  Rebalancing is rebalancing, IMO.  If one rebalance strategy is "market timing", then they all must be labeled that. Regardless, you're basically saying that the 15/35 bands are not market timing, but other methods are.  Also, it's not as if the 15/35 rebalancing bands weren't based on some sort of backtesting.  The fact is, no one will know what rebalance strategy will be the best over the next two decades until 2032.  All we have to go on is past performance.

And again if these strategies were so reliable, why aren't the people running them billionaires already?


Are there any billionaires that have made their money from the HBPP?  I don't think the OP was advocating this rebalance method as a way to put up 30% pa returns.  However getting an extra 1% from optimal rebalancing would be worth it over the course of my investing career, even if that didn't result in me becoming a billionaire.  

[craigr]

Are there any billionaires that have made their money from the HBPP?  I don't think the OP was advocating this rebalance method as a way to put up 30% pa returns.  However getting an extra 1% from optimal rebalancing would be worth it over the course of my investing career, even if that didn't result in me becoming a billionaire.  

To be clear, there are very few people that make millions from investing prowess alone. Except if they are in the business of selling the advice and not following it as others have said in the past. Being able to save, grow and protect your career earnings is most important. You might also lag a passive investor by 1% doing these timing strategies. And in fact basically every study I've seen on market timing indicates that's the usual income (at least).

But these topics keep coming up and I guess it's human nature to tinker. I was just responding to the question with my opinion. That opinion is that these kinds of strategies don't work. Never have. Never will. But it's not my money so I don't have a dog in the fight.

[AdamA]

OP, thanks for sharing that paper.

Craigr, why do you refer to this rebalancing strategy as "market timing" yet you advocate using rebalancing bands, correct?

I agree that certainly more frequent rebalancing COULD affect taxes and transaction costs depending on whether one is using a taxable or tax privileged account. Fees could be an issue but if you're using TDameritrade, VBS, Scottrade, etc, it probably wouldn't be a significant change.

I get the gist of strategy, but it was unclear to me exactly how it worked.

1.  How often (on average) does it require you to buy/sell?
2.  Is there the potential to get whipsawed in and out of trades?

Psychologically, I like the PP because it requires so little decision making, so I'm not crazy about adding anything that complicates it at all.  I'm not saying the technique won't work, just that it does complicate the PP a little more which, for me, makes it unappealing.  If I wasn't so sure that there was a benefit, I wouldn't even bother to rebalance.  

[MediumTex]

I have been thinking about this question of "in what way is the PP not driven by a type of market timing?"

I think that the PP differs from typical market timing strategies in that it doesn't ask you to buy or sell based upon the price action of any one asset, but rather the price action of the assets functioning as a package.

It's also important to remember that with the PP we are not really seeking non-correlation among the assets so much as we are seeking proxies for non-correlated (or maybe I should say "distinct") economic environments.

The fact that the PP has certain characteristics that make it resemble a market timing strategy on the surface is, to me, sort of an incidental feature that doesn't provide much insight into what is really happening with the PP's assets (i.e., they are providing protection in multiple economic environments, while assuming that changes in economic environments cannot be predicted reliably).

[stone]

I need to read through the linked piece but on the face of it it sounds like it is a way to decide that "today is a day when rather than 15%-35% rebalancing bands being appropriate; 22%-28% bands are appropriate". To my mind the two broad strategies the PP follows are "hedging" and "momentum trading". Holding all of the four assets at the same time is "hedging". Allowing the ratios to drift away from 25% to the 15%-35% bands is "momentum trading". I suppose the choice of whether "hedging" is better or "momentum trading" is better is just down to how much random jittering around there is. Last August/Sept? when every day seemed to have a 4% move, perhaps very tight rebalancing bands with frequent rebalancing might have paid for the trading costs if you knew what you were doing. I'm sure that for an insider with co-located HFT etc it was a bonanza and they probably rebalanced on a second by second basis In steady, trending markets perhaps the 15%-35% bands are unneccessarily tight.
I agree that it all rests on whether volatility that matters gives a forewarning in the form of volatility that you can detect and take note of. I guess that that all depends on what causes it. If an asset has become "overbought" and that is causing market jitteryness, then I guess that could manifest as a period of volatility that could be a warning sign. On the other hand something like 9/11 2001 comes out of the blue with no warning.
Perhaps this method could be used as a way to decide to do a premature PP rebalance? Let's say you had one asset at 33% and you noticed that volatility was getting very choppy. It wouldn't seem stupid to me to rebalance

[stone]

I just read the link and it is intruging. I suppose if you really wanted to aggressively apply this to a "corrupted " PP, you could shift the alocations between 15% and 35% say depending on the 20day trailing volatility. So if stock VIX was very high you would set stocks to 15% and if it was very low then shift to 35%. It wasn't clear to me whether high  volatility for long term treasury prices is also supposed to be indicative of a crash in price for those. I got the impression that the authors were just using intermediate term bonds to make up whatever wasn't stocks in a stock:bond portfolio. To be honest perhaps just using stock volatility as something to possibly trigger a premature rebalance back to 25% from a PP that had drifted to being overweight stocks would be a more measured way to incorporate this concept into a PP strategy.

The appendix about Japan and Canada was also interesting:
"Traditional SAA with rebalancing delivered 1.5% annualized per year in Japan over the past 18 years. What’s worse, Japanese investors experienced two entire bull/bear cycles over this period where they saw their wealth begin to grow again only to watch it collapse over and over. This must have been psychologically excruciating.
While a traditional 50/50 allocation with rebalancing struggled to deliver returns (but delivered an abundance of hope and despair), relative volatility weighting provided investors with tolerable, if not robust, results of 4.4% annualized over the period, with a reasonable Sharpe ratio of 0.72. Further, the portfolio never experienced a loss greater than 15.44% from peak to trough."

[craigr]

Hey Guys,

Just wanted to publicly apologize to clacy about my responses. I have been kind of ill-tempered lately for unrelated reasons and didn't mean to come off so snotty.

[melveyr]

I think that the higher return associated with 15/35 rebalancing bands can be thought of as a fortuitous market timing benefit.

The 15/35 rebalancing bands benefit from medium-term momentum (holding more of the asset class that is rising the most), and then longer-term reversion to the mean (shifting these momentum gains into the lagging asset class).

This is definitely a market timing benefit.

However, the alternative is simply not practical. To be truly neutral at all times would require re-balancing every business day. This would be extremely expensive for numerous reasons. Therefore, I think that going with the  15/35 bands is more prudent, even though it has a market-timing element.

[AdamA]

This is definitely a market timing benefit.

I guess you're right, but I just hate to think of rebalancing as timing.  Really, it's just common sense.  We know nothing goes up forever, and I think rebalancing is just a way of acknowledging this and saying, "it will probably come down some time, I'm not just not sure when."  

Some of the technical indicators used to try to market time are just a little more abstract.  I'm a little bit less skeptical of their effectiveness than others who don't like them.  I think there is a chance that there is some benefit, because they tend to reflect market psychology and "the madness of crowds."  

The thing is, they don't always work, sometimes for very long periods of time, and I think it takes a very disciplined investor to stick to them during these dry spells in order to realize the eventual premium.  Most people can't do this, and I don't even want to try.  

And, as always, you'd have to make sure you were using tax advantaged accounts and minimizing transaction costs.  

However, the alternative is simply not practical. To be truly neutral at all times would require re-balancing every business day. This would be extremely expensive for numerous reasons. Therefore, I think that going with the  15/35 bands is more prudent, even though it has a market-timing element.

Well put.  

[clacy]

Hey Guys,

Just wanted to publicly apologize to clacy about my responses. I have been kind of ill-tempered lately for unrelated reasons and didn't mean to come off so snotty.

Craig,

No apology is needed.  I did not take it for snippy.  I enjoy debating subjects such as this and I that is one of the main reasons for frequenting forums such as this. I find the conversations on this forum to be much more civil than most boards and enjoy that aspect of this site.  But asking tough questions is probably the single best way to dissect any strategy, HBPP included.

[MachineGhost]

It sounds like a modified risk parity approach.  Basically, set the level of volatility you want your portfolio to be at the outset, then every quarter rebalance back to that risk parity level by normalizing the then 20-day trailing volatility back to the initial level.

Example: Stocks were 20% and Bonds were 10% at the outset.  After 90 days, say the volatility for Stocks is 15% and Bonds 12%.  So the new allocation to stocks would be 20%/15% or Current Value * 1.33 and Bonds would be 10%/12% or Current Value * .8333.

It could be better than a typical risk parity portfolio which tends to have low nominal CAGRs as all asset classes are normalized to a single volatility level.  20-days doesn't really sound like its going to be long enough in duration to avoid negatve regimes.  Do note what the white paper said about market timing:

"Further, Advisors should incorporate well documented sources of informed bias, such as value, sentiment, breadth, seasonality, and momentum, to further skew portfolios away from, and toward, asset classes with below average, or above average prospects respectively. This type of framework should be robust to asset classes, market regimes, and exogenous shocks, and provide a much more stable return experience for investors."

MG

I happened to find this document, which is about maximizing rebalancing gain by volatility based dynamic rebalancing method, not by conventional periodic rebalancing.

http://www.macquarieprivatewealth.ca/da ... rected.pdf

However, I could not find any specific method to implement this approach, the only clue I could find was 'based on 60 day trailing volatility'

I think this approach is very logical and reasonable and I'd like to apply to my actual trading.

Do you have any idea on this approach?