William Sharpe advises against rebalancing

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Beliavsky
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William Sharpe advises against rebalancing

Post by Beliavsky »

Allocate by Market Weight (And Adjust for Personal Circumstances)
Charles Rotblut (CR): I’d like to discuss allocation, starting with rebalancing. A lot of people either psychologically have a problem doing it or just won’t do it. What are your thoughts?

William Sharpe (WS): I think, by and large, people probably shouldn’t do it. In particular, rebalancing by selling winners and buying losers. Basically, if you’re going to sell your winners and buy your losers, then you have to trade with someone. And that person has to take the other side of the trades. If you’re smart doing that, then the other person must be dumb to trade with you. So the questions are: Why is that a good thing to do, and what’s the matter with the other person for trading with you?

We can’t all rebalance, because rebalancing to pre-selected proportions means selling relative winners and buying relative losers. Since we can’t all do that, the question is: If this is the obvious thing to do, with whom are you going to trade? Who is it? And why should the other person trade with you? In an efficient, sensible or informed market, such rebalancing will not be a good strategy.

I would like to see a very-low-cost index fund that buys proportionate shares of all the traded stocks and bonds in the world.
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Re: William Sharpe advises against rebalancing

Post by flyingbison »


William Sharpe (WS): ... In an efficient, sensible or informed market, such rebalancing will not be a good strategy.
I'm not sure such a market exists in the real world.
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Re: William Sharpe advises against rebalancing

Post by Gropes & Ray »

That quote doesn't look like he's recommending against rebalancing a stocks/bonds index portfolio. It looks like he's recommends against rebalancing a portfolio of individual stocks.

Update: Now that I read the whole article, he is initially referencing bonds, also, but later accepts that risk tolerance will change with age and should be reflected in your stock/bond allocation.
Last edited by Gropes & Ray on Thu Sep 04, 2014 8:55 am, edited 1 time in total.
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Re: William Sharpe advises against rebalancing

Post by dbr »

Rebalancing in BH land is about a very fundamental prescript to keep the overall risk of a portfolio within some reasonable range of what one wants. In the long run that pretty much amounts to selling stocks that have gained more than bonds over a long time so that one does not end up with a very high stock allocation. Even the idea that one "must" sell bonds and buy stocks during a stock market crash is susceptible of modification. I don't think Sharpe is thinking about the same thing at all.
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Re: William Sharpe advises against rebalancing

Post by midareff »

I view rebalancing strictly as risk control measure. Whether it be stocks/bonds, International/Domestic, etc., that's what it is. You either do or don't have an AA .... whether it be equities to FI or within classes of equities your portfolio will drift over time. Correcting that drift at some point in time or deviation to return to your established AA and risk is nothing silly, it is sound financial and portfolio management.
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Re: William Sharpe advises against rebalancing

Post by nisiprius »

I think a more interesting thing in the article is his wish for "a very-low-cost index fund that buys proportionate shares of all the traded stocks and bonds in the world." It certainly sounds like something Vanguard could do easily if they wanted to, but Sharpe says he's talked to his "friends in the index fund business" and they aren't interested.

Since Vanguard already has the building blocks needed in the form of four individual funds*, it would seem that the minimum size needed to justify the costs of setting up the fund wouldn't need to be too large. It's just a fund of funds that already exist and are already being used in the Target Retirement and LifeStrategy series. Total World is $6 billion and was able to eliminate all their "this-is-not-a-load-fees" a while ago, and LifeStrategy Income is viable with $3 billion in assets. I'd think a "Total World Securities" fund could capture that much. Perhaps the problem is that there isn't actually an index provider with a "Total World Securities" index yet?

It answers a question that sometimes gets asked in the forum--whether one should cap-weight the proportions of stocks vs. bonds in one's portfolio to match the grand total collective capitalization of stocks vs. bonds in the world; his answer is clearly "yes."
A reporter interviewing Sharpe wrote:I would like to see a very-low-cost index fund that buys proportionate shares of all the traded stocks and bonds in the world. Unfortunately, there are none at present. It would be good if there were one or more used by a great many investors as their main investment vehicle. While such a fund is not available, you can construct one from existing index funds, but then you have to monitor the current world values of the components—for example, the value of all the U.S. bonds for the U.S. bond index fund, the value of all the non-U.S. bonds for that fund and the value of all the world stocks for that fund. I’ve talked to my friends in the index fund business, and thus far nobody seems to be interested in producing that. It is a huge hole and individual investors could really use such a fund.

CR: You’re talking about all securities in the fund?

WS: All traded bonds and stocks in the world. What a great default investment that would be if it were really low cost. To my knowledge, it doesn’t exist.

CR: Do you think it’s just because of the cost or the difficulties?

WS: I don’t know. It’s hard to get anybody to produce a low-cost index fund, because you can’t make a great deal of money because it’s low cost. Now, many people have home bias and conclude that it is enough to buy a U.S. bond fund and a U.S., or possibly a world, stock fund. But there may still be gains from diversifying your bonds globally as well.
*OK, it isn't the total universe of "all the traded stocks and bonds in the world" but I don't think that's the issue, since he says "you can construct one from existing index funds, but then you have to monitor the current world values of the components—for example, the value of all the U.S. bonds for the U.S. bond index fund, the value of all the non-U.S. bonds for that fund and the value of all the world stocks for that fund."
Last edited by nisiprius on Thu Sep 04, 2014 9:25 am, edited 3 times in total.
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Re: William Sharpe advises against rebalancing

Post by Aptenodytes »

I read through the interview quickly and have to say it just didn't make any sense to me. The stuff about being puzzled over why two rational people would want to trade with each other seems sophomoric. Similarly, the notion that it would be wonderful if there were a fund that mirrored the combined bond and stock markets of the world seems daft.
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Re: William Sharpe advises against rebalancing

Post by nisiprius »

Aptenodytes wrote:I read through the interview quickly and have to say it just didn't make any sense to me. The stuff about being puzzled over why two rational people would want to trade with each other seems sophomoric
It did seem to me that since rebalancing involves relative winners and losers, it is possible that two investors could be both be selling their winners to each other, if their portfolios were very different.
Similarly, the notion that it would be wonderful if there were a fund that mirrored the combined bond and stock markets of the world seems daft.
I wouldn't happen to want it myself, but it hardly seems "daft."
Last edited by nisiprius on Thu Sep 04, 2014 9:21 am, edited 1 time in total.
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Re: William Sharpe advises against rebalancing

Post by ObliviousInvestor »

The following paper from Sharpe may be of interest:
http://web.stanford.edu/~wfsharpe/retecon/wfsaaap.pdf

In particular, the part on page 14 where he quotes an earlier work of his.
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Re: William Sharpe advises against rebalancing

Post by dbr »

nisiprius wrote:
Aptenodytes wrote:I read through the interview quickly and have to say it just didn't make any sense to me. The stuff about being puzzled over why two rational people would want to trade with each other seems sophomoric
It did seem to me that since rebalancing involves relative winners and losers, it is possible that two investors could be both be selling their winners to each other, if their portfolios were very different.
Similarly, the notion that it would be wonderful if there were a fund that mirrored the combined bond and stock markets of the world seems daft.
I wouldn't happen to want it, but it hardly seems "daft."
I put the whole thing down to the stuff people say in interviews that just doesn't make any sense at all. I don't know if Sharpe is known for being a good off-the-cuff speaker, but there are a lot of well known smart people who do great research, write great books and articles and can't talk coherently about anything in a conversation. I had some very famous professors in college whose books are world famous but who were awful lecturers.
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Re: William Sharpe advises against rebalancing

Post by Browser »

Our mentor, John Bogle, also thinks that rebalancing is an unnecessary exercise.
“If you can ignore market fluctuations along the way, it’s better not to rebalance, since you’re likely to get higher returns.” In a recent study, he looked at how a portfolio with 70% in stocks and 30% in bonds performed when rebalanced annually vs. when left alone. “Over the 187 25-year periods ending between 1826 and 2012, the rebalanced portfolio earned a sliver less on average,” Money reports. “In 55% of the periods, rebalancing beat doing nothing, by an annualized 0.23%, adjusted for inflation. When rebalancing hurt returns, the penalty was larger — 0.43%.”
http://theguruinvestor.com/2013/10/11/b ... -stand-it/

But, if it helps you to sleep better that's OK too, he says. Just don't kid yourself that it improves returns. There's no way in the world that reducing your stock allocation (because it has grown) to buy bonds will improve your long term returns. Stocks have higher returns than bonds, remember?
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Re: William Sharpe advises against rebalancing

Post by Rick Ferri »

Sharpe's view on "adaptive asset allocation" doesn't make sense to me. His philosophy of passive investing is correct (low-cost, low turnover, broad diversification), but his idea that every investor should have the same global balanced strategy is not accurate. Investors should hold an asset allocation that's right for their unique situation.

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Re: William Sharpe advises against rebalancing

Post by kramer »

I sure am glad that I rebalanced in late 2008 and early 2009.
We can’t all rebalance, because rebalancing to pre-selected proportions means selling relative winners and buying relative losers. Since we can’t all do that, the question is: If this is the obvious thing to do, with whom are you going to trade? Who is it? And why should the other person trade with you? In an efficient, sensible or informed market, such rebalancing will not be a good strategy.
How about a young investor buying assets while investing his growing work earnings and an older investor selling his risky assets to gradually reduce his risk . . . seems like a good buyer/seller match to me.
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Re: William Sharpe advises against rebalancing

Post by jackpistachio »

Browser wrote:Our mentor, John Bogle, also thinks that rebalancing is an unnecessary exercise.
“If you can ignore market fluctuations along the way, it’s better not to rebalance, since you’re likely to get higher returns.” In a recent study, he looked at how a portfolio with 70% in stocks and 30% in bonds performed when rebalanced annually vs. when left alone. “Over the 187 25-year periods ending between 1826 and 2012, the rebalanced portfolio earned a sliver less on average,” Money reports. “In 55% of the periods, rebalancing beat doing nothing, by an annualized 0.23%, adjusted for inflation. When rebalancing hurt returns, the penalty was larger — 0.43%.”
http://theguruinvestor.com/2013/10/11/b ... -stand-it/

But, if it helps you to sleep better that's OK too, he says. Just don't kid yourself that it improves returns. There's no way in the world that reducing your stock allocation (because it has grown) to buy bonds will improve your long term returns. Stocks have higher returns than bonds, remember?
What about risk-adjusted returns? Did the study look at that, or just absolute returns? This is a thread on Sharpe after all.

Yeah, don't get the argument about always having a winner and a loser in a trade. Several scenarios can be though of where both are winners, or even where both are losers, depending on their personal needs and circumstances.
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Re: William Sharpe advises against rebalancing

Post by nisiprius »

A lot of the "rebalance/don't rebalance" stuff is just talking past each other unless it's made clear what's meant by rebalancing.

Before the advent of target-date funds, traditional life-cycle advice generally suggested no more than four portfolios to cover every life stage--e.g. Vanguard's LifeStrategy funds: 80/20, 60/40, 40/60, and 20/80. It's not one size fits all, but four sizes fit all--and simple round numbers.

So, if the point of rebalancing is to make sure your portfolio is in tune with your risk tolerance, both those numbers and common sense suggest that stock allocation only needs to be "accurate" to within 10% of total portfolio. Even a huge runup like 1990-1999 only changes a 40/60 allocation into ($10000->$49,700 in VFINX, $10000->$20,700 in VBMFX, math math math -> 19800/12420) = 62/38.

Without rebalancing, the biggest bull market in my investing lifetime only heats up a "conservative" allocation to a "moderate" allocation.

So, if you simply take four model portfolios, 80/20, 60/40, 40/60, and 20/80, and only rebalance when you have drifted out of one category into the next... plus de-risking with age... you are only going to be rebalancing perhaps four or five times in your life.

That doesn't seem like an imprudent amount of "trading" to do.

The big issue is the other meaning for "rebalance." I don't quite know how to characterize it, but part of the mystique (yes, I'm going to call it 'mystique') of multi-asset investing and the emphasis on the supposed importance of rebalancing, involves frequent rebalancing--and involves investing in fairly volatile asset classes that are hopefully uncorrelated, in the belief that by doing so you will be capturing a "rebalancing bonus" due to systematically buying low and selling high (probably nonsense) or exploiting "mean reversion" between asset classes (probably not total nonsense).

Obviously Sharpe is NOT saying "don't rebalance." He's saying rebalance "what’s right for you given your particular circumstances" and, as the interviewer notes, it has an "element of subjectivity." I think he does support infrequent adjustments asset allocation based on changes in risk tolerance and life circumstances.
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Re: William Sharpe advises against rebalancing

Post by richard »

This seems a better explanation of Sharpe's views on rebalancing.
CR: What about adaptive allocation? I know you’ve written about the subject.

WS: Here is a simple way to think about this. Assume that at the moment stock values are 60% of the total value of bonds and stocks, that bond values are 40% and that you just want to have the risk and return of the average investor. Then you should invest 60% in stocks, 40% in bonds. And now, let’s say, stocks go up and bonds go down, so the market values are now 70%/30%. If you want to continue to be the average investor, you should have 70%/30% proportions. But when you look at your portfolio values, you are likely to find that they are already close to 70%/30%. And you didn’t have to do anything. This won’t be exactly the case due to new security issues and things of that sort, so you might have make some minor adjustments, probably when reinvesting dividends and bond payments. But the trades will be small. The idea is to have a policy that indicates what proportions you want when the market proportions are, say 60%/40%, and then keep your relative risk constant as market values change (Figure 1). The formula that I suggest for adaptive asset allocation works from this basic policy and indicates the proportions that you should have as market proportions change.

In the simplest case where you just want to take the risk of the average investor, the formula just says that your policy should be to hold the same proportions as the market. If you want to have a policy of being more risky than the average investor, then you have to look at the formula. But it’s a very easy formula.
This would not be appropriate if you believe stocks have constant risk (or constant risk relative to bonds) or if you are better at valuing securities than the market.
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Re: William Sharpe advises against rebalancing

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WS: All traded bonds and stocks in the world. What a great default investment that would be if it were really low cost. To my knowledge, it doesn’t exist.
Here's a BusinessWeek article from 2006, In Search of a Global Index Fund, where they talk about basing a fund on the MSCI Global Capital Markets Index. That sounds like exactly what Sharpe is looking for.

Unfortunately, no fund ever materialized. And, since MSCI stopped making the index breakdown public, it would actually be pretty difficult to do it yourself, as their doesn't seem to be another freely-available definitive source.
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Re: William Sharpe advises against rebalancing

Post by whomever »

"what’s the matter with the other person for trading with you?"

You can look at that both ways. Let's say Nisiprius and I have identical portfolios - $100 of bonds and 100 shares of stocks @ $1 a share. There is a big panic selloff, like 2007/2008. Now we both own $100 in bonds and $50 of stocks. I panic and say 'OMG, I'll sell my shares cheap'; why shouldn't Nisiprius trade me $25 of his bonds for 50 shares of my stock?

In this case, what's the matter with me is that I'm panic selling. If Nisiprius has the nerves to say 'this is a temporary bear market, that will recover within my investing horizon', bully for him. It's certainly not irrational for him to rebalance. He may regret it, if the downturn is longer than expected (Japan), but it's not irrational.
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Re: William Sharpe advises against rebalancing

Post by bs010101 »

I don't think it's correct to say that the other side of the trade has the opposite opinion of the markets, especially when dealing with index funds. I automatically buy index funds twice a month in my retirement account, and someone must be selling them to me. But I don't buy them because I think the market is heating up, so why expect the other side is selling because they think the market is cooling down? Maybe they have automated RMDs from their retirement account.
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Re: William Sharpe advises against rebalancing

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nisiprius wrote:I think a more interesting thing in the article is his wish for "a very-low-cost index fund that buys proportionate shares of all the traded stocks and bonds in the world." It certainly sounds like something Vanguard could do easily if they wanted to, but Sharpe says he's talked to his "friends in the index fund business" and they aren't interested.
When you look at the breakdown of all the investable assets in the world (from this recent paper), it doesn't look too different from a moderately conservative balanced fund (with several spicy slices added to it). It has about 45% equity and 55% bonds — which could be approximately duplicated with an existing global balanced fund (with the spicy slices added or not).

Image
Source: The Global Multi-Asset Portfolio
Last edited by SimpleGift on Thu Sep 04, 2014 10:50 am, edited 2 times in total.
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Re: William Sharpe advises against rebalancing

Post by Browser »

As to "risk-adjusted returns" from rebalancing, it depends on the "return" part during the period of time involved. For example, for a portfolio divided equally between U.S. stocks and intermediate-term bonds, during the 1972-1981 period (a period of relatively poor stock returns), the risk-adjusted return and absolute return from rebalancing was a little better than for not rebalancing - although both were poor. But over the period 1982-1999, (a period of relatively high stock returns), both the risk-adjusted and absolute returns from not rebalancing were higher than for rebalancing. Risk-adjusted portfolio returns don't tell you anything more than absolute returns - they both depend heavily on equity performance during the period of time involved. If stock returns are high, then rebalancing hurts both absolute and risk-adjusted returns and vice versa. The idea that re-balancing automatically improves risk-adjusted returns is just plain wrong.
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Re: William Sharpe advises against rebalancing

Post by Rodc »

kramer wrote:I sure am glad that I rebalanced in late 2008 and early 2009.
We can’t all rebalance, because rebalancing to pre-selected proportions means selling relative winners and buying relative losers. Since we can’t all do that, the question is: If this is the obvious thing to do, with whom are you going to trade? Who is it? And why should the other person trade with you? In an efficient, sensible or informed market, such rebalancing will not be a good strategy.
How about a young investor buying assets while investing his growing work earnings and an older investor selling his risky assets to gradually reduce his risk . . . seems like a good buyer/seller match to me.
Or an older person selling to generate income?
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Re: William Sharpe advises against rebalancing

Post by nisiprius »

Simplegift wrote:When you look at the breakdown of all the investable assets in the world (from this recent paper), it doesn't look too different from a moderately conservative balanced fund (with several spicy slices added to it). It has about 45% equity and 55% bonds — which could be approximately duplicated with an existing global balanced fund (with the spicy slices added or not)...
Yes, that's a great chart and probably a good paper (haven't read it), thanks for reposting it in this thread. And that's the point. I don't happen to want it, but it's certainly not crazy. It's certainly no crazier than a lot of... crazier... ideas like, say, the S&P 500 equal weighted index, or 130/30 funds, or "risk parity" investing, or commodity allocations, etc. etc.
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Re: William Sharpe advises against rebalancing

Post by SimpleGift »

Actually, when looking at the global market portfolio over time, I'm not sure that much rebalancing would be required for risk reduction. It has only deviated about +/- 10% from a 50% stock/50% bond mix over the last 50 years.

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Re: William Sharpe advises against rebalancing

Post by staythecourse »

I only have two things to add:

1. Much respect to Prof. Sharpe, but if he still believes the market is full of rational investors then he is as wrong as he was when the wrote about CAPM.
2. Simplegift simply has the BEST graphs I have ever seen consistently put on this forum!! :D

Good luck.
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Re: William Sharpe advises against rebalancing

Post by Aptenodytes »

nisiprius wrote:
Simplegift wrote:When you look at the breakdown of all the investable assets in the world (from this recent paper), it doesn't look too different from a moderately conservative balanced fund (with several spicy slices added to it). It has about 45% equity and 55% bonds — which could be approximately duplicated with an existing global balanced fund (with the spicy slices added or not)...
Yes, that's a great chart and probably a good paper (haven't read it), thanks for reposting it in this thread. And that's the point. I don't happen to want it, but it's certainly not crazy. It's certainly no crazier than a lot of... crazier... ideas like, say, the S&P 500 equal weighted index, or 130/30 funds, or "risk parity" investing, or commodity allocations, etc. etc.
The static picture isn't too nutty, but nor it is especially compelling. It is one way to invest among hundreds of reasonable ways; the odds that it suits me is virtually nil (I'm with Rick on this). What I find daft is the dynamic implication -- that as the global asset mix shifts one direction or another, I should too. I can see that for equities, for the reasons the efficient market people have proven. But for the universe of all investable assets, I just don't get it.

The line graph that simplegift posted after the pie chart shows what I mean. It is a bit hard to tell from the way the chart was composed, but I'm eyeballing a big drop in equities from about 1999 to the present, on the order of about a third (from around 60% to around 40%). There's a simultaneous big increase in corporate bonds (here the graph choice makes it very hard to estimate the numbers but it is a big jump). Why in the world would I want to cut my stock percentage by a third over this period?

To the extent that a lot of the dynamic shift is driven by prices, which seems to be somewhat true from eyeballing the graph, then following Sharpe's ideas would have you doing quite a lot backwards -- you'd buy more stocks when prices go up and you'd sell off when they fall. I don't have a Nobel prize, but I'll stick with doing it the other way around.
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Re: William Sharpe advises against rebalancing

Post by mptness »

Simplegift wrote:When you look at the breakdown of all the investable assets in the world (from this recent paper), it doesn't look too different from a moderately conservative balanced fund (with several spicy slices added to it). It has about 45% equity and 55% bonds — which could be approximately duplicated with an existing global balanced fund (with the spicy slices added or not).
Thank you for the link to the very interesting paper. I also found this recent article in Forbes by Phil DeMuth about the "Global Market Portfolio."
http://www.forbes.com/sites/phildemuth/ ... -investor/

I wonder what the current (2014) asset weights would be. The authors of the paper point out that the the weight of equities was low in 2012.

From the paper:
The weight of equities in 2012 is close to the record low in 2011 of 37.1%. In 2011, for the first time in our sample period, equities no longer
outweighed government bonds.
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Re: William Sharpe advises against rebalancing

Post by mptness »

Aptenodytes wrote:To the extent that a lot of the dynamic shift is driven by prices, which seems to be somewhat true from eyeballing the graph, then following Sharpe's ideas would have you doing quite a lot backwards -- you'd buy more stocks when prices go up and you'd sell off when they fall. I don't have a Nobel prize, but I'll stick with doing it the other way around.
It does seem like a fund that tracked this "Global Market Portfolio" would be trading more often than a typical index fund or balanced fund.
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Re: William Sharpe advises against rebalancing

Post by lee1026 »

You can look at that both ways. Let's say Nisiprius and I have identical portfolios - $100 of bonds and 100 shares of stocks @ $1 a share. There is a big panic selloff, like 2007/2008. Now we both own $100 in bonds and $50 of stocks. I panic and say 'OMG, I'll sell my shares cheap'; why shouldn't Nisiprius trade me $25 of his bonds for 50 shares of my stock?
In other words, you think that the other side is stupid. The EMH is premised on that you are generally no smarter then the trader on the other side.
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Re: William Sharpe advises against rebalancing

Post by nisiprius »

mptness wrote:
Aptenodytes wrote:To the extent that a lot of the dynamic shift is driven by prices, which seems to be somewhat true from eyeballing the graph, then following Sharpe's ideas would have you doing quite a lot backwards -- you'd buy more stocks when prices go up and you'd sell off when they fall. I don't have a Nobel prize, but I'll stick with doing it the other way around.
It does seem like a fund that tracked this "Global Market Portfolio" would be trading more often than a typical index fund or balanced fund.
No, it wouldn't. To a first approximation it wouldn't have to trade at all.

It would have to trade in order to acquire new issues, and in some cases it would have to trade to take account of changing exchange rates. But basically that's the whole idea of a cap-weighted portfolio. It mirrors the market portfolio. You acquire the number of shares, or the number of bonds, that duplicates the cap-weighting of the market (or all of the world's capital markets, in this case). The market cap of each holding is the price per share or bond times the number of shares or bonds outstanding. If the relative market values change, the relative total capitalization of the two assets changes--and so does the relative capitalization of the fund's holdings.
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lee1026
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Re: William Sharpe advises against rebalancing

Post by lee1026 »

It would have to trade a lot. Dividends, share buybacks, secondary offerings, employee stock grants (which is basically a mini secondary offering), IPO, going private, will all throw off stock weights. On the bond side, every new issue will throw it off.
Browser
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Re: William Sharpe advises against rebalancing

Post by Browser »

Yes, I believe CAPM is consistent with cap-weighting. Sharpe isn't a great fan of tilting or "smart beta", which represent deviations from cap weighting. He says he is "fairly dismissive of the anomaly literature," and that anyone who believes there is sufficient historical data to make a determination that premium on certain types of stocks is any different from the market with any degree of precision is "just kidding himself."
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Deceptor
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Re: William Sharpe advises against rebalancing

Post by Deceptor »

Rebalancing, on any scale: strategic, operational, or tactical; class, style, or sector, by selling winners and buying losers does not make sense to me.
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