Using Trend Exposure to Offset Rebalancing Risk
Summary
The document reviews research on the negative convexity of periodically rebalanced stock and bond portfolios. Rebalancing maintains target weights, but it repeatedly sells assets that have gained and buys those that have lagged. When stocks and bonds move together during a decline, this can deepen losses compared with buy and hold. The article describes the return difference as resembling a short straddle and examines historical evidence for a 60/40 portfolio from 1960 to 2017.
It presents two ways to add trend exposure: allocate a portion of the portfolio to stock and bond trend strategies, or delay some rebalancing when a trend signal is negative. The reviewed results indicate that both approaches reduced drawdowns in several severe historical episodes, while some trend allocations preserved returns. Simpler changes to rebalancing frequency or thresholds generally had smaller effects. These findings depend on the historical sample, signal choices, trading assumptions, and portfolio design; they do not establish future performance. The article also notes that cash flows, taxes, broader diversification, and other risk controls matter in practice.
Key ideas
- Periodic rebalancing can deepen losses when stocks and bonds decline together because it maintains fixed target weights.
- The article characterizes the return difference between rebalancing and buy and hold as negatively convex to relative stock and bond performance.
- Trend strategies can provide positive convexity that may offset some of rebalancing’s downside exposure.
- Investors can add trend exposure directly or delay partial rebalancing when a trend signal is negative.
- The reported drawdown improvements come from historical analysis and may not persist in future markets.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.