Dynamic Risk Rebalancing for Investment Portfolios

• Activity Number: 146
• Type: Contributed
• Date/Time: Monday, August 12, 2002 : 2:00 PM to 3:50 PM
• Sponsor: Section on Risk Analysis*
• Author(s): Kurtay Ogunc*+
• Affiliation(s): Watson Wyatt Worldwide
• Keywords: Portfolio rebalancing ; Risk budgeting ; Change-point problems ; Investment management

Abstract

Effective portfolio rebalancing helps institutions, such as pension plans and endowments, systemically manage total risk. In so doing, institutional investors make better informed decisions regarding the allocation of the risk budget, and thus, the composition of their portfolios. Risk budgeting has been recently introduced to the portfolio management community to reiterate the importance of risk management. Many institutional investors have taken the view of utilizing the concept of risk budgeting as an effective tool to generate consistent excess returns over strategic benchmarks. The changes in the dynamics of asset return distributions result in deviations from the optimal allocation level of the risk budget. This mismatch between the desired and actual active risk over time, coupled with structural breaks in return series, necessitates the use of a systematic rebalancing strategy. The continuous monitoring of return series of asset classes and the total portfolio will enable institutions better identify points of structural change. The "dynamic portfolio rebalancing" approach, using a statistical methodology, will make sure the portfolio stays within acceptable risk parameters.