# Optimal Rebalancing Of A Value Stock Portfolio



## Park (Sep 11, 2010)

https://www.acsu.buffalo.edu/~keech...ALANCING ON SIZE AND BOOK TO MARKET RATIO.pdf

The above study looked at low price/book stocks in the US between 1963-1988. They divide the market into quintiles by price/book and market cap. After 1.0% transaction costs and annual rebalancing, investors would have outperformed the market by 4.82%, if they invested in the 4% of the market that consisted of the smallest and cheapest stocks by quintile. With 2.0% transaction costs, the outperformance was 3.89%. See Table 2. 

What was the optimal rebalancing frequency? Table 3 addresses that question. It assumes 1% transaction costs. Yearly return outperformance for a rebalancing period of 1 year was 5.28%, 2 years 7.14%, 3 years 7.05%, 4 years 6.93%, 5 years 6.32%, 6 years 5.99%, 7 years 5.84%, 8 years 5.35%, 9 years 4.90% and 10 years 4.42%. 

This paper was written mostly by academics, and I don't understand it completely. For example, why the difference between 4.82% and 5.28?

Nevertheless, I find it relevant. When you read the quantitative value literature, the question of holding period and costs is often not addressed. For example, "What Works On Wall Street" by James O'Shaugnessy or "Quantitative Value" by Wesley Gray and Tobias Carlisle or "Quantitative Strategies For Achieving Alpha" by Richard Tortoriello assume annual rebalancing and don't mention costs.

A 4 year holding period gave a yearly return that was only 0.21% less than the optimal 2 year holding period. And the 4 year holding period was 1.65% greater than the 1 year holding period.

The above assumes 1% transaction costs. In a taxable account, there will be cap gains to pay, and a 4 year holding period will defer those taxes longer than a 1 or 2 year holding period. In a taxable account, I wouldn't be surprised if a 4 year holding period was better than a 2 year holding period.


----------



## james4beach (Nov 15, 2012)

I can't comment on those specifics. But before you get too excited about value stock strategies, look at context. This study was during a period (1963 to 1988) when stocks were among the cheapest in history. The CAPE (Shiller PE) averaged just 15. There were value stocks all around.

The US market hasn't seen those kinds of valuations since 1991. Today the CAPE is over 26 and there are hardly any value stocks out there. Just beware that the methods in such a paper may be totally irrelevant for an environment like we've had post 1990


----------

