Traders' Roundtable

Does anyone have any suggestions on how to adjust the portfolio?
The ratio of my portfolio is shown as below:
Stock 50%
Bond 30%
Cash 20%

Since the market is moving everyday, does anyone have any suggestion on how to maintain this ratio on regular base? It is impossible to maintain the ratio for stock by adjusting from 51% to 50% based on everyday's price movement. Does anyone have any suggestions?
Thank you in advance
Eric

The issue of portfolio rebalancing comes up both in the dynamic hedging/replication of options (via deltas), and the theoretical study of optimal portfolio weights (Markovitz, correlations, efficient frontier, etc).

Uniformly practitioners in finance agree that periodic rebalancing is sufficient and also necessary for reducing transaction costs.

to take a practical example. generally for instance, options will be priced at a spread to their Black Scholes prices due to the fact the equation assumes "instantaneous delta hedging" - an impossibility. With discrete hedging assumption (daily/weekly) that spread can be quantified (through monte-carlo walk-forward of hedging portfolio for instance.)

Ok, my answer might seem a bit obscure - on the other hand there might be some detail in it which of interest to some readers - I am just trying to provide background and a practical example on where this issue is encountered and dealt with practically by investment houses who for instance attempt to replicate option payoffs by buying stock and selling options.

The real answer is that you shouldn't worry about instantaneous portfolio rebalancing, but rather look to systematically rebalance at a period that you find appropriate, for instance monthly or bi-monthly, or otherwise look for triggers such as % deviation to be a signal to correct the portfolio balance.

As long as you are consistent in the methodology you choose.

Here are some articles that show a different way to allocate your assets. Risk Parity Allocations. It is basically a way to allocate your assets based upon how risky an asset class is.

http://www.bwater.com/PDFs/engineering_ ... 060215.pdf
https://content.putnam.com/panagora/pdf ... folios.pdf

Nelson Freeburg recently did a study of this and the results are very very encouraging. http://www.formularesearch.com

Happy Trading,
David

Thank everyone very much for suggestions
Eric

oem, it all depends on your risk tolerance, if you're conservative you'll put only up to 15% of your equity into stocks, another 15% into Mutual Funds and the rest 65% into bonds(corporate, government etc). and having 5% cash. It doesnt matter if markets move everyday, if you're that type of investor you'r going for a long run(at least a 1 year hold), so simply dividing your equity into that type of proportion would make a job for you. I suppose most members on this forum hold 100% in futures..

oem7110 wrote:Does anyone have any suggestions on how to adjust the portfolio?
The ratio of my portfolio is shown as below:
Stock 50%
Bond 30%
Cash 20%

Since the market is moving everyday, does anyone have any suggestion on how to maintain this ratio on regular base? It is impossible to maintain the ratio for stock by adjusting from 51% to 50% based on everyday's price movement. Does anyone have any suggestions?
Thank you in advance
Eric

Thank for your reply

If I divide my equity into following proportion,
15% Stocks
15% Mutual Funds
65% Bonds
5% Cash
Should I look at this proportion only once per year and re-adjust everything back to this proportions? Does it what you mean to let the proportion do the job for me?
I look forward to your reply
Thank everyone very much
Eric

Eric,

You may wish to read this excellent paper by Mebane Faber-->
http://tinyurl.com/2nunzs

Regards,
Ed

It is an enjoyable paper and pleasantly free of mathematical notation. I seem to recall that Mr Faber does not however employ re-balancing.

TB is an excellent tool for testing asset allocation for yourself, with or without re-balancing, but CSI does not provide many total return indices so you have to find or make your own.

As to the commodities part, the GSCI is heavily weighted towards energies and you might want to construct a more balanced index or use the DJAIG (which only goes back to 1991). Assuming you want to test commodity exposure at all.

Equally you could use a TF system for this portion of your asset allocation in tests.

It really depends on your portfolio make-up and what type of strategy that you are employing. If you are running a buy and hold type of strategy, then once a year is sufficient for rebalancing ... in my opinion. There are a number of papers on this if you do a google search. Also, I believe that one of the analysts here did his own study. I think that he said that once a year or so is good. You can add a little more value by doing it quarterly or monthly but it usually only provides a small increase in return. Not enough to really make it worth it.

Turbowagon, how do you download that paper? I have never heard of the three applications, and not being in the US dont have an SSRN. Any help please?

Thanks:)

Turbowagon attached it to a post of his here:
viewtopic.php?t=3022&highlight=mebane+faber

A recent paper might be of some interest, which uses information theory as a supplement to the mean-variance optimization. See the front page of wilmott.com