Managing Multi-Asset Portfolios in Turbulent Market Environments

Executive Summary

Portfolio rebalancing is a crucial but perhaps underappreciated aspect of multi-asset portfolio management, whose importance was highlighted by the extreme market volatility of recent quarters. The rebalance policy supports larger risk and return objectives captured in a portfolio’s strategic and tactical asset allocation targets, which incorporate an asset manager’s alpha strategy. However, rebalancing involves tension between transaction costs and tracking error, or how closely the portfolio adheres to its targeted allocation. These costs rise exponentially in times of market stress. As a result, a robust rebalance policy must account for market regime. In most environments, where transaction costs are low and markets are highly liquid, narrow rebalance bands strike a good balance between cost and risk control. But when volatility spikes, costs rise and liquidity evaporates, wider bands become preferable. Ultimately, we believe that rebalance guidelines are preferable to hard and fast rules, and that active managers and traders can add significant value precisely when volatility spikes.

Key Takeaways

  • There is no “one ring to rule them all”—no single rebalance policy is superior under all circumstances. Our analysis of rebalance strategies over roughly the last 20 years shows that no one policy reliably produces the best outcomes.
  • The tradeoff between cost and risk control under typical market conditions (in terms of trading costs and liquidity) argues for fairly narrow rebalance bands. We find that a reasonable balance between minimizing costs and controlling risk comes with asset class bands of approximately 2%, rebalancing halfway to target.
  • Under periods of high volatility when trading frictions rise (i.e., correlations and trading costs surge and liquidity falls), tighter bands become undesirable and indeed can be counterproductive as the portfolio is whipsawed by market movements. Under such periods, it is preferable to widen the bands to about 5%, lowering the frequency of rebalancing.
  • Alpha should be derived from the larger portfolio allocation decision and should not be thought of as an objective or outcome of an “optimal” rebalance policy. And while return is not a specific objective of a rebalance policy, a well-designed rebalance strategy should not impose costs that reduce returns.
  • There is an important role for active management in the rebalance policy during periods of extreme volatility—insights about trading costs and execution, market liquidity and investment opportunity can be particularly impactful at such times.

Managing Multi-Asset Portfolios in Turbulent Market Environments

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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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