What Does Rebalancing Really Achieve?

There is now a substantial literature on the effects of rebalancing on portfolio performance. However, this literature contains frequent misattribution between ‘rebalancing returns’, which are specific to the act of rebalancing, and ‘diversification returns’, which can be earned by both rebalanced and unrebalanced strategies. Confusion on this issue can encourage investors to follow strategies that involve insufficient diversification and excessive transactions costs. This paper identifies the misleading claims that are made for rebalanced strategies and demonstrates in theory and by simulation that the apparent advantages of rebalanced strategies over infinite horizons give an inaccurate impression of their performance over finite horizons. Copyright © 2016 John Wiley & Sons, Ltd.