Michael Severino and Jeffery Chalmers are portfolio managers for Parthenon Asset Advisors. Severino and Chalmers both believe that having defined criteria for rebalancing a portfolio provides discipline in their portfolio management process, but they have different opinions on how to go about it. Severino states, “With calendar rebalancing, a portfolio could spend the majority of its existence looking extremely different from the target asset allocation, but trades made to rebalance the portfolio may only have a minor impact on how the portfolio is allocated.” Chalmers replies, “If we use percentage-of-portfolio rebalancing, there may never be a trade placed to rebalance our client portfolios.” With regard to their statements about rebalancing methods:
A) Severino is incorrect; Chalmers is correct. B) Severino is correct; Chalmers is correct. C) Severino is incorrect; Chalmers is incorrect.
If the portfolio is extremely different from the target allocation, then the rebalancing trades cannot have a minor impact on the allocation (unless there’s something I haven’t considered).
But "… trades made to rebalance the portfolio may only have a minor impact on how the portfolio is allocated.” make little sense to me. How the portfolio is allocated depends on the IPS and market condition, not on trade and rebalancing.
My thought on this is if say the portfolio undertakes a quarterly rebalancing schedule then for 2.5 months between each rebalancing date the portfolio could be way out of wack, but then right before rebalancing time rolls around it comes back to the policy allocation and so the actual trades needed are minor. if the portfolio does this every qtr, it could spend most of its life far from policy allocations, but require minimal trading impact each rebalancing date.