| Summary: | Portfolio managers typically have two choices: let the portfolio drift with the
markets or give direction to the portfolio by rebalancing according to a target
allocation. Simply allowing the portfolio to drift with the markets without
rebalancing is no longer appropriate. This leaves portfolio managers with the
second option of giving direction to the portfolio according to a target allocation.
'This can be achieved by implementing an existing rebalancing strategy. Portfolio
managers typically rely on ad hoc rebalancing strategies that are either calendar-based,
such as monthly or quarterly rebalancing, or volatility-based, such as
rebalancing whenever the asset ratios are more than 5% from the target.
In the volatility-based rebalancing strategies, the percentage from the target
indicates when rebalancing should occur, and the percentage relies on rule of
thumb or the use of historical data. The problem with using historical data is that
it will not necessarily predict appropriate ranges for the future. These ranges
give the indication of when rebalancing should occur. This indicates a need to
develop a well-defined rebalancing strategy that assists the portfolio manager to
manage a portfolio. Such a rebalancing strategy should be easy to implement.
The aim of this research was to develop and implement a well-defined
rebalancing strategy that is adjustable over time to assist portfolio managers to
maintain their portfolios in line with the objectives and risk aversions of the
trustees' of a pension fund.
The study introduced the concept of a portfolio drift strategy to set the scene for
the different rebalancing strategies. This was to emphasise the importance for a
portfolio manager to adopt a rebalancing strategy for a pension fund. An
overview is provided of the five broad rebalancing strategies followed by some
advantages and disadvantages of each.
Certain rebalancing strategies were used to explain the benefit of rebalancing
and the cost of rebalancing. The study investigated different methodologies used
to identify when the portfolio manager should rebalance and how far back the
portfolio manager should rebalance.
The study focused on Masters' range rebalancing strategy and this strategy was
used as the benchmark strategy for the study. The study summarises the
benchmark strategy that will be used to evaluate the alternative rebalancing
strategies. A selective number of performance measurement tools were used to
evaluate the benchmark strategy. This criterion was used to compare the
alternative rebalancing strategies.
The study introduced a new decision-making method that has the same return as
the benchmark strategy but the risk of the portfolio is lower. The decision-making
method is called the second difference method (SD-method). The SD-method
builds on Masters' range rebalancing strategy by eliminating certain implicit
assumptions made by Masters. The elimination of Masters' implicit assumptions
led to an increase in the complexity of the SD-method of the procedure to
rebalance. The complexity was eliminated using a computer program
formulating the rules of the SD-method.
The study developed a new method called the Cusum Test method (CT-method)
with its own assumptions and risk specifications to identify when rebalancing
should occur. The new method discussed in the study was less complex to
implement and, in contrast to Masters' range rebalancing, the ranges were
adjustable over time. The CT-method outperformed Masters' range rebalancing
strategy and the SD-method on a risk-adjusted return basis. === Thesis (Ph.D. (Risk Management))--North-West University, Potchefstroom Campus, 2007.
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