Portfolio Design: A Modern Approach to Asset Allocation

REBALANCING DEFINED

Rebalancing is the term used to describe the periodic adjustment of a portfolio to restore a strategic asset allocation. Rebalancing sounds so sensible in theory. You rebalance in order to keep investments in line with your original allocation. In practice it is very difficult to carry out. Consider the experience of investors in 1999 as shown in Figure 16.1. In 1999 growth stocks had soared, while value stocks just lumbered on. The Russell 1000 Growth Index registered a 33.2 percent return while the Russell 2000 Growth Index gave a return 10 percent higher than its large cap counterpart. An investor who believed in asset allocation should have rebalanced away from these growth investments into the value sector even though the Russell 1000 Value Index had returned only 7.3 percent in 1999. But given the splendid performance of the growth sector, how many investors were willing to sell their winners and buy their losers? It takes an awful lot of discipline to rebalance when one type of investment is doing so well. Besides, the investor assured himself that this time it is different. The world had changed and growth stocks, tech stocks in particular, no longer had to follow ordinary rules.

FIGURE 16.1 Russell Growth and Value Returns in 1999 and 2000

Data Source: Russell®.

Little did the investor know that the tide was about to change. In the following year, ...