Working papers and journal-published research from the investment and research team at Newfound Research.
Title & Authors
Corey Hoffstein, Justin Sibears, and Nathan Faber
Prior research demonstrates that performance can be highly sensitive to index construction choices related to rebalance dates. The authors define the measure of rebalance timing luck as the standard deviation in returns between identically managed investment portfolios that are rebalanced on different dates (sub-indexes). Using a simple fixed-mix strategy, the authors identify that rebalance timing luck can have significant implications for realized results. Statistical tests imply that the ex ante expected returns for the sub-indexes are identical and that realized performance differences are not expected to mean-revert over time. The authors demonstrate that investors can minimize the impact of rebalance timing luck through equal-weight exposure to the sub-indexes. The authors propose an ex ante model to estimate the magnitude of rebalance timing luck and to confirm that the process of equal weighting across N sub-indexes reduces rebalance timing luck by 1/N.
Corey Hoffstein, Nathan Faber, and Steven Braun
Prior research and empirical investment results have shown that portfolio construction choices related to rebalance schedules may have non-trivial impacts on realized performance. We construct long-only indices that provide exposures to popular U.S. equity factors (value, size, momentum, quality, and low volatility) and vary their rebalance schedules to isolate the effects of “rebalance timing luck.” Our constructed indices exhibit high levels of rebalance timing luck, often exceeding 100 basis points annualized, with total impact dependent upon the frequency of rebalancing, portfolio concentration, and the nature of the underlying strategy. As a case study, we replicate popular factor-based index funds and similarly find meaningful performance impacts due to rebalance timing luck. For example, a strategy replicating the S&P Enhanced Value index saw calendar year return differentials above 40% strictly due to the rebalance schedule implemented. Our results suggest substantial problems for analyzing any investment when the strategy, its peer group, or its benchmark is susceptible to performance impacts driven by the choice of rebalance schedule.