Rebalancing and Returns.indd - Dimensional Fund Advisors

Rebalancing and Returns 13
I conduct a second out-of-sample test using data from January 2005 to July 2008.
The allocation is the same as in Tables 1-3; and the annualized arithmetic average net
returns, averaged over the 12 monthly starts, are displayed in Table 5. The optimal
strategies add about 7 basis points over the benchmark (60, 10%) strategy and about
35 basis points over no rebalancing. However, in this sample, the best three strategies
are the (1, 5%), the (250, 0%), and the (10, 10%). The previous winner, the (1, 20%)
strategy, now ranks only 27th out of 42. Moreover, the best strategies appear almost
random, which is what one would expect if return differences across strategies were
mainly driven by noise in returns. Panel B, which displays the difference in return relative
to the benchmark (60, 10%) strategy, supports this. Except for the (1, 0%) strategy,
which has abysmal returns because of frequent, costly trading, none of the strategies
has returns that significantly differ from the benchmark strategy.
The returns for the core and component portfolios in this later sample are displayed in
Table 6. 7 Once again, the (1, 20%) rebalancing strategy does not produce the highest
returns. Comparing the core and component portfolios in Panel C, the core outperformed
the component strategies for 9 of the 42 strategies, although, with the exception
of the (1, 0%) strategy, these differences are all statistically insignificant. The largest
return difference occurred with the (1, 10%) strategy, which gave the component portfolio
a 9 basis point advantage over core. However, in the previous period, the return
advantage using the (1, 10%) strategy was the opposite, with the core portfolio having
a return about 20 basis points higher than the component portfolio. There is simply no
empirical evidence to support the idea that breaking asset classes into smaller components
can produce reliably higher returns through rebalancing opportunities.
Is There a Rebalancing Return Benefit
In both of the periods examined so far, the non-rebalanced portfolio has experienced
lower returns than any of the rebalanced portfolios. Even if there is no single rebalancing
strategy that will produce the highest returns for every portfolio in every period, can
this be interpreted as evidence that rebalancing in general produces some return benefit
Again, 11.5 years is a fairly short period of time when dealing with noisy historical returns.
Thus, to empirically test whether rebalancing in general has return benefits over
not rebalancing, I obtain monthly US stock and bond data from July 1926 to June 2008.
I form a portfolio in July 1926 with 60% in equities and 40% in bonds. The equity
portion combines six Fama/French portfolios formed on size and book-to-market, with
weights of 12% in each of three large capitalization portfolios (Large Value, Large Neutral,
and Large Growth), and 8% in each of three small capitalization portfolios (Small
7. As in the previous sample, the component weights are determined by their average weights in the
year prior to portfolio formation, from January 2004 to December 2004. Specifically, the Russell 1000
Value, the Russell 1000 Growth, the Russell 2000 Value, and the Russell 2000 Growth had weights of
42.30%, 45.75%, 5.00%, and 6.95% respectively. These weights were scaled to sum to 45%.