Perpetual life portfolios ⇒ few changes in time horizon, risk budgets & asset allocation.. 3.1.1 Rebalancing Benefits Transaction costs offset rebalancing benefits.. Drawback: If alloc
Trang 1“MONITORING AND REBALANCING”
2 MONITORING
Fiduciary must:
Act in a position of trust
Assess portfolio suitability relative to client’s needs & circumstances
Monitor investor related circumstances, market & economic changes
& portfolios
∆ in the needs, circumstances or objectives of private wealth clients (institutional clients) are reviewed on a semiannual or quarterly basis (annual basis)
More frequent reviews may be required on client’s request or unexpected
∆ in client circumstances
2.1.1 Changes in Investor Circumstances and Wealth
May affect income, expenditure, risk, return &
retirement income
2.1.2 Changing Liquidity Requirements
Portfolio managers:
Provide liquidity when requested by a client
Monitor changes in liquidity requirement
2.1.3 Changing Time Horizons
the time horizon, investment, allocation to bonds
Perpetual life portfolios ⇒ few changes in time horizon, risk budgets & asset allocation
2.1.4 Tax Circumstances
Portfolio manager should:
Assess tax consequences of investment decisions
Consider client’s current & future tax situation
Trang 22.2 Monitoring Market and Economic Changes
A portfolio’s asset allocation may change due to ∆ in mean return, volatility & correlation of assets
2.2.1 Changes in Asset Risk Attributes
Major market swings provide extreme +ve or –ve opportunities
Investors tactically adjust asset allocations or individual security holdings based on their opinions
2.2.2 Market Cycles
Expansionary monetary policy ⇒ discount rates,
stock return
Restrictive monitory policy ⇒discount rates, bond return
2.2.3 Central Bank Policy
Default RF yield curve reflects:
Expected inflation
Maturity premium
Time preference for real consumption
Maturity premiums are countercyclical
Sharpe of the Y.C depends on the economic cycle stages
Y.C provides information about future GDP growth
2.2.4 The Yield Curve and Inflation
Continuous process requiring a manager to assess:
Events & trends affecting asset classes & individual holdings
∆in asset values creating deviation from the SAA
Trang 33 REBALANCING THE PORTFOLIO
3.1 The Benefits and Costs of Rebalancing
In PV of expected utility losses
Controls the level of drift in overall portfolio risk
Maintains desired systematic risk exposure
Removes overpriced assets with an inferior returns prospect
3.1.1 Rebalancing Benefits
Transaction costs (offset rebalancing benefits)
Tax costs if investor is taxable
3.1.2 Rebalancing Costs
3.2 Rebalancing Disciplines
Periodic rebalancing to target weights (e.g
monthly)
Rebalancing frequency may be timed to match with portfolio reviews
Simplest approach
No continuous monitoring required
Drawback:
If allocation is close to optimal allocation rebalancing cost > benefits
If allocation is far from the optimal,
level of market impact costs
3.2.1 Calendar Rebalancing
Rebalancing thresholds or trigger points stated as % of portfolio value
Require frequent monitoring
Directly related to market performance
Tighter control on divergence from target allocation
3.2.2 Percentage-of-Portfolio Rebalancing
Key Determinants of the Optimal Corridor Width in a Percentage- of-Portfolio Rebalancing Program:
Factor Effect on Optimal Width of Corridor Intuition Factors Positively Related to Optimal Corridor Width
Transaction costs The higher the transaction costs,
the wider the optimal corridor
Higher transaction costs set a high hurdle for rebalancing costs to overcome
wider the optimal corridor
High risk tolerance implies lower sensitivity to divergences from target allocations
Correlation with rest of portfolio The higher the correlation, the
wider the optimal corridor
When asset classes move in synch, further divergence is less likely
Factors Inversely Related to Optimal Corridor Width
Asset class volatility The higher the volatility of a given
asset class, the narrower the
A given percentage move away from the target
Trang 43.2.3 Other Rebalancing Strategies
Monitor the portfolio at specified intervals
Rebalance the portfolio under % principle
Avoid incurring rebalancing cost when the portfolio is nearly optimal
Calendar-And-Percentage-Of-Portfolio Rebalancing
Corridors are specified for each asset class
Rebalancing is triggered when any asset class weight moves outside its corridor
Equal probability of triggering rebalancing
Ignores difference in transaction costs or asset correlations
Equal Probability Rebalancing
In trending markets less frequent rebalancing
More frequent rebalancing when markets are characterized by reversals
Tactical Rebalancing
Rebalancing to an allowed range has the following advantages over rebalancing to target weights:
Transaction costs
Tactical adjustments are possible
Better manage the weights of an illiquid assets
Disadvantage:
Not perfectly align actual asset allocation with target proportions
3.2.4 Rebalancing to Target Weights versus Rebalancing to the Allowed Range
Optimal rebalancing strategy implies:
Maximize rebalancing benefits
Transaction costs
Challenges:
Rebalancing costs & benefits are difficult to measure
Tax consequences
Optimal strategy changes with the passage of time
3.2.5 Setting optimal Thresholds
Trang 53.3 The Perold-Sharpe Analysis of Rebalancing Strategies
Passive do-nothing strategy
Floor = amount invested in T-bills
Risk tolerance is +ly related to wealth & stock returns
Special case of CPPI
In trending market, this strategy outperforms constant mix strategy
This strategy remains neutral in flat & oscillating market
Portfolio value = investment in stocks +floor value
Limited downside (floor) & unlimited upside potential
Target stock proportion = actual stock proportion (m=1)
3.3.1 Buy-and-Hold Strategies
Reacts to market movements
Target investment in stocks = m × portfolio value
where 0<m<1
m = target stock proportion
() actual stock proportions to m when stock values are trending ()
Effectively maintains a portfolio’s systematic risk
During strong bull & bear markets this strategy underperforms CPPI & buy & hold
Outperforms CPPI & buy & hold when equity returns are characterized by reversals
3.3.2 Constant-Mix Strategies
Dynamic strategy
Buy(sell) shares as stock prices ()
Target investment in stock = m ×(portfolio value- floor value)
If m>1, strategy is known as CPPI
Investment in RF assets is dynamic
Perform well in trending markets & poor in markets characterized by reversals
3.3.3 A Constant-Proportion Strategy: CPPI
Constant mix & CPPI strategies are non-linear whereas buy & hold strategies are linear
Constant-mix strategies (CPPI strategies) ⇒ relationship b/w portfolio & stock returns ⇒ concave (convex)
Concave strategies provide liquidity to convex strategies
3.3.4 Linear, Concave, and Convex Investment Strategies
Investor’s risk tolerance & asset class return expectations are parameters for appropriate rebalancing strategies
3.3.5 Summary of Strategies
3.4 Execution Choices in Rebalancing
3.4.1 Cash Market Trades 3.4.2 Derivative Trades