The Importance of Rebalancing ETF Investment Portfolios | ETF Trends

It is important for investors to regularly rebalance their exchange traded fund holdings, trimming some outperformers and adding to underperformers.

The importance of rebalancing is reflected in the outperformance of target date and “asset allocation” fund strategies driven by end-of-quarter rallies whenever the U.S. stock market slips, the Financial Times reports.

According to analysis by Vincent Deluard, global macro strategist at StoneX, over the past six years, the S&P 500 index has returned an average annualized rate of 80% in the final week of quarters in which the index has declined.

“Stocks have rallied by an absurd 80.6 per cent per annum in the last week of the quarter during down quarters since 2016,” Deluard told the Financial Times, adding that it was an example of “miraculous seasonal patterns in the passive era.”

The S&P 500 also outperformed over the final week of any month in which the market has retreated, reflecting that the once commonly observed “momentum” effect in markets appears to be less prominent.

Deluard highlighted target date funds and similar asset allocation-based mutual and exchange traded funds are inherently contrarian when rebalancing. These strategies aim to hold a fixed proportion of equities and bonds, so if equities underperform bonds in a given period, the strategies rotate into equities in order to bring their positions back in line with their target allocation. The opposite also occurs if stocks have outperformed bonds over a period.

“What has gone down must be bought and what has gone up must be sold,” Deluard said of the strategies.

These rebalancing periods typically range from monthly, quarterly, or semi-annually.

Dave Nadig, chief investment officer and director of research of ETF Trends and ETF Database, argued that target date funds may “get a little bit too much emphasis” in Deluard’s analysis, but he added that even if target date fund strategies were largely responsible for the phenomenon, it would not affect their investment popularity.

“Investors like TDFs because they work. The average mid-career investor in a TDF is much better diversified, at much lower fees, with much better expected outcomes, than if they were simply doing it all on their own,” Nadig told the Financial Times.

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