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Like many teenagers, I read The Dice Man because the idea of the novel’s protagonist making decisions based on the roll of a die sounded rebellious and fun. I gave it a try too — but soon quit when the numbers I wanted never came up.
Later at university, my friend Trevor and I simplified things. We founded the Yes Generation, a club of two where the only rule was to answer in the affirmative to everything asked of us (attending lectures excluded, naturally).
This approach to everyday life also failed. So now I know that randomness is no good, nor the same response every time. With hindsight, I should have just done the opposite of everything I chose to do. Why didn’t South Korea’s president call me?
Studied liberal arts rather than economics. Lived in the antipodes. Not giving that speech. I should have turned left instead of right into a car. Needless to say, selling my US equity fund last year is on the list.
Believing in the flipside of what feels obvious is why I have always loved constraints when it comes to investing. Especially the automatic rebalancing of portfolios, which usually goes against every bone in your body.
Your winners go up, so you are forced to bring their weightings down again. Those rubbish stocks that have lost you a fortune? Press the “buy button” you must. It hurts like blazes, but the simplicity and contrariness appeals.
Rebalancing also seems validated by flow data. Investors are vulnerable to hype — being the biggest bullish at the top of a cycle and uber-negative at the bottom. Exactly the opposite of how to make money.
For example, in the two months alone before the peak of the S&P 500 in 2007, domestic net inflows were $20bn, according to LSEG Lipper data. After the financial crisis, in the nine months following the market low in March 2009, net outflows were still $40bn.
A disciplined rebalancing strategy overcomes the temptation to buy high and sell low. If you wanted your portfolio at 25 per cent in US equities, it would have bagged pre-crisis profits all the way up by selling every week or month, using the cash to jump in again as everyone panicked.
This is also the reason so-called roboinvesting makes sense to me. Similarly, the fact that private equity funds don’t allow us to withdraw our cash in a huff (and hence can purchase cheap assets in a sell-off) is key to their performance record.
All sounds nice, doesn’t it? Unfortunately, rebalancing is mostly claptrap. Not just in theory, but also in practice. The problem in the academic literature is definitional woolliness. The problem for real-world investors is buy-and-hold strategies tend to do better.
I won’t be nerdy for readers enjoying their weekend, but a big issue is that most studies focus on expected returns. These rely on a number of assumptions (as I have written about before). Key is that prices “mean-revert”. If they drop, they will eventually recover and vice versa.
Over theoretically infinite periods, therefore, a strategy of owning volatile assets and selling them if they rise above trend and buying them if they fall below trend will outperform a static portfolio. But that’s a truism.
Back on planet Earth it is impossible to know if a favourite stock is out of whack one way or another. What is more, the likes of the Cass Business School show that it is the enhanced diversification of rebalancing that creates the pixie dust, not the trading itself.
More important for investors still is over shorter periods expected returns may not normalise — as US equities have shown for almost two decades. Those who ignored the textbooks and let their American stocks run are killing any rebalanced portfolio.
And we still haven’t mentioned the worst thing about constantly readjusting our holdings. Triggering capital gains tax seriously damages returns. In addition, non-institutional investors such as you and me are charged hefty commissions.
How much damage is a factor of tax rates, the size of gains and losses, as well as how far your portfolio is from being optimally diversified. It is a nasty calculation requiring more than just your fingers and toes.
Luckily I haven’t had to do it this year. That’s because — spookily — the weightings of my five exchange traded funds have barely changed. The reason is because my biggest equity ETFs are all up between 12 and 15 per cent. Even the 4 per cent return in treasuries has only reduced my exposure from 29 to 27 per cent.
Indeed this is one of the reasons I haven’t rushed into buying some of my good ideas in 2024, as I wrote a fortnight ago. None of my funds has outperformed the others by so much it screamed out to be culled.
And that is never a good reason to sell anyhow. What matters is valuation, as I keep banging on about. The fact is, I’m still happy with the absolute as well as relative attractiveness of Japan, the UK and Asia. Especially versus the US.
Top-slicing is the way to go then, if I want to make room for a new fund or two. My self-managed pension cops no capital gains tax. What is more, it makes scant difference if I pay commission on five funds or one.
Certainly the timing feels OK to realise some gains. Thanks to Donald Trump, risk assets such as equities are going bonkernuts, as my daughter Jean might say. The year-to-date return of my portfolio is double-figures at last.
A full percentage point above the 9 per cent annually I need to double my money before turning 60, as per my stupidly ambitious goal. Of course if I’d put it all in bitcoin this year I’d already be there.
The author is a former portfolio manager. Email: [email protected]; Twitter: @stuartkirk__