Risk-based rebalancing thresholds

Rebalancing strategies play an important role in ensuring asset portfolio continues to meet its stated objectives in volatile markets. In designing a rebalancing strategy, there needs to delicate balance between managing transaction costs and accurately implementing the objectives.

In this paper, we explore the concept of using a whole-of-portfolio risk-based measure to determine when rebalancing trades are triggered, as well as a transaction cost optimised approach when determining the instruments to trade. To illustrate the impact of this, we then compared the concept against more conventional rebalancing strategies on a typical dynamic hedging program for a Variable Annuity guarantee over backtested and simulated real-world scenarios.

We found that by limiting rebalancing trades to only when the whole-of-portfolio risk is material, we can significantly reduce the expected transaction costs whilst achieving a similar level of hedge effectiveness.