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Re: Can't Prune a Target Fund
Old 07-24-2006, 10:46 PM   #41
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by sgeeeee
While I agree about the intuitively obvious part, I did not think that Bernstein sounded like he recognized that "rebalancing bonus" was bogus.* See for example:

http://www.efficientfrontier.com/ef/996/rebal.htm
In this paper, Bernstein says:

Markowitz1 considers the return of a portfolio to be equal to the weighted sums of the individual component returns, but this formulation is valid only for nonrebalanced portfolios over single periods.

This tells me that he understands that weighted sums of annualized returns aren't comparable to multi-year multi-component returns.

He also says:

... the 69 year period studied the significantly higher stock return overwhelms the bond return; for the last 40 years of the period the unrebalanced portfolio consists of greater than 90% stock

and

They suggest that convex portfolio insurance strategies as well as buy and hold ("flat") strategies produce superior returns in markets with a prolonged upward (or downward) bias, and concave rebalancing strategies produce superior returns in stagnant markets.

So, he understands why buy-and-hold usually will have higher returns for stock/bond mixes.

But then he goes on to say:

The above theoretical model and backtested portfolios suggest that significant excess return is available from combinations of asset pairs which have both low correlation and high risk.

Both he and Gummy go on to estimate what this bonus is for high-variance assets with similar returns but low correlation, which seems to be the only time you get the bonus.

Neither the SG study nor the justin study addresses this directly.*
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Re: Can't Prune a Target Fund
Old 07-24-2006, 10:54 PM   #42
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by wab
. . .

Neither the SG study nor the justin study addresses this directly.*
The study doesn't address a lot of things directly. It wasn't intended to. The data shows that there are periods when rebalancing paid off (about 40% of the time in my study). Since you can't predict the correlation of assets in the future, knowing what the correlation coeficient needs to be to gain a rebalance bonus is hardly helpful.

You could address this issue by looking at the correlation coeficients of the individual sequences, ordering them and looking at how those results correlate to a rebalance bonus. But that seems rather pointless. I would be happy to send you my spreadsheets if you are interested in the mental masterbation, however.
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Re: Can't Prune a Target Fund
Old 07-24-2006, 11:30 PM   #43
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by sgeeeee
Since you can't predict the correlation of assets in the future, knowing what the correlation coeficient needs to be to gain a rebalance bonus is hardly helpful.*
I'm not sure we're talking about the same thing here.* *I've already stated that the rebalancing bonus is obviously bogus due to a variety of factors, including covariance drift.* *Your study shows this to be true for portfolios comprised of S&P 500 stocks and bonds.* *Bernstein himself tells you why there is no bonus for this case.

So, the question remains: are there cases in which you are much more likely to get a rebalancing bonus?

Bernstein says, "the intrinsic rebalancing potential of any asset pair is the difference between its mean variance and covariance."

In other words, you're most likely to see the bonus with highly volatile assets with low correlation.

Are you saying that your S&P 500 / bond mix is a good test case for his assertion?
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Re: Can't Prune a Target Fund
Old 07-25-2006, 12:04 AM   #44
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by wab
. . .
Are you saying that your S&P 500 / bond mix is a good test case for his assertion?
You are so tedious sometimes, wab. What I'm saying is that over different periods of time, the S&P 500 and bond returns would exhibit unique (higher or lower) volatility and correlation properties. Since the rebalance strategy paid a bonus 40% of the time, you could order the 102 simulated sequences by volatility or correlation and examine the corrleation between these properties and the existence of a bonus.

My guess is that you wouldn't because other factors would dominate. And that points to the reason I would refer to Bernstein's derivation as mental masterbation.

But you knew all this, wab. Didn't you?
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Re: Can't Prune a Target Fund
Old 07-25-2006, 12:16 AM   #45
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by sgeeeee
While I agree about the intuitively obvious part, I did not think that Bernstein sounded like he recognized that "rebalancing bonus" was bogus. See for example:

http://www.efficientfrontier.com/ef/996/rebal.htm

[...]

A short time after Bernstein published the report cited above, he published this one:

http://www.efficientfrontier.com/ef/197/rebal197.htm
"When Doesn't It Pay to Rebalance?"

So maybe Bernstein does really understand that the rebalance bonus is bogus, but by the time I read the second paper I had already run a check using historical data. I wanted to confirm what seemed obvious to me.
He admitted that the first article was a mistake over on Diehards a few months ago: http://socialize.morningstar.com/New...eq=61#replyTop
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Re: Can't Prune a Target Fund
Old 07-25-2006, 12:28 AM   #46
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Re: Can't Prune a Target Fund

Quote:
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He admitted that the first article was a mistake over on Diehards a few months ago:* http://socialize.morningstar.com/New...eq=61#replyTop
Thanks, bpp. My impression was that he figured out his first article was misleading and decided to provide a more practical answer in the second.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 12:36 AM   #47
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Re: Can't Prune a Target Fund

Cool.* If I had seen that M* bit, it would have saved me from much head scratching.

So, in the end he admits that the bit about the sum of the weighted returns is bogus, but he says the results still hold for cases in which two assets have similar returns with high volatility and low correlation.

That makes more sense to me.* *So, here's where I think that leaves the bonus:

It makes sense to rebalance between two asset classes if you know they have similar expected returns, high volatility, fairly fixed covariance, and you know the period of their covariance and can time the peaks and valleys.

In other words, not very often.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 12:47 AM   #48
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by wab
. . . It makes sense to rebalance between two asset classes if you know they have similar expected returns, high volatility, fairly fixed covariance, and you know the period of their covariance and can time the peaks and valleys.

In other words, not very often.

Yeah.

The real reason to rebalance is to maintain risk at your personal comfort level. Which indicates that you should rebalance based on your allocation varying significantly from your target allocation levels -- not based on a schedule.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 08:09 AM   #49
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by sgeeeee

Yeah.

The real reason to rebalance is to maintain risk at your personal comfort level. Which indicates that you should rebalance based on your allocation varying significantly from your target allocation levels -- not based on a schedule.
I'm convinced. Makes blended/target/strategic funds a bit more appealing to me.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 10:21 AM   #50
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by wab
It makes sense to rebalance between two asset classes if you know they have similar expected returns, high volatility, fairly fixed covariance, and you know the period of their covariance and can time the peaks and valleys.
I'm just guessing when I invest. A few components of my portfolio are what I would call "risky" (ie high volatility) with expected returns greater than the S&P 500. However, I don't really know what the returns, volatility or covariance will be in 20 or 30 years. As a result, a large portion of my portfolio is in less volatile investments. I'm primarily afraid of the "fat tails" scenario where almost everything is down (with the risky stuff seeing MAJOR losses). It will happen more than the normal distribution would suggest. Hopefully periodic rebalancing will allow me to capture some upside from riskier asset classes and will allow me to limit my downside.

In other words, I want to limit my overall portfolio volatility while capturing a portion of the higher than average expected returns.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 05:20 PM   #51
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Re: Can't Prune a Target Fund

Quote:
Originally Posted by sgeeeee
The real reason to rebalance is to maintain risk at your personal comfort level. Which indicates that you should rebalance based on your allocation varying significantly from your target allocation levels -- not based on a schedule.
Bingo-- when an asset with a desired 25% allocation reaches 30% then it's probably time to find a way to rebalance... either by selling it for spending cash or by selling it to buy a lagging asset class.

I think 2008's reduction on cap gains to zero for the 10-15% income tax brackets is going to drive "rebalancing" activity through the roof.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 06:32 PM   #52
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Re: Can't Prune a Target Fund

Is that reduction a sure thing or is it still negotiable? I've been expecting that to be rejiggered any time now. I didnt read through the last tax bill detail to see if that had been given any sort of approval to stay in place.

Sure would be a mighty fine time to change asset allocations and make major changes.
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Re: Can't Prune a Target Fund
Old 07-25-2006, 06:40 PM   #53
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Re: Can't Prune a Target Fund

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Is that reduction a sure thing or is it still negotiable?* I've been expecting that to be rejiggered any time now.* I didnt read through the last tax bill detail to see if that had been given any sort of approval to stay in place.
Well, I guess it could change anytime up through 15 April 2009... I don't remember reading about any changes this session either.

Yeah, I think 2008 will be the year that we sell off the rest of our Tweedy, Browne holdings with their $15/share cost basis. There'll be plenty of time in 2009 to buy something else at a discount!
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