Bridge over ocean
15 March 2024 Financial Analysts Journal Volume 80, Issue 2

Smart Rebalancing

  1. Robert D. Arnott
  2. Feifei Li
  3. Juhani T. Linnainmaa
Live portfolio performance rarely matches backtests or paper portfolios. Trading costs and other frictions cause implementation shortfalls. “Smart rebalancing” to prioritize trades merits study, no less than the factors themselves.
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The sometimes vast gap between live results and paper portfolio performance is caused in part by trading costs, discontinuous trading, and missed trades or other frictions, along with asset management fees. Smart beta and factor strategies are not exempt from this “implementation shortfall.” This paper provides new evidence on the efficacy of prioritizing transactions so as to focus portfolio turnover on the trades that offer the strongest signals and hence the highest potential performance impact. Rebalancing filters of this sort can capture much of the factor premia for a long-only paper portfolio while cutting turnover and trading costs relative to a fully rebalanced portfolio.

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