MONITORING AND REBALANCING

Question 1

31.a: Discuss a fiduciary’s responsibilities in monitoring an investment portfolio.

Question 2

31.b: Discuss the monitoring of investor circumstances, market/economic conditions, and portfolio holdings and explain the effects that changes in each of these areas can have on the investor’s portfolio.

Question 3

31.e: Contrast calendar rebalancing to percentage-of-portfolio
rebalancing.

Answer 3

calendar rebalancing refers to rebalancing a portfolio to its
strategic allocation on a predetermined, regular basis (e.g., monthly, quarterly, or
annually).

With percentage-of-portfolio rebalancing (PPR), also referred to as percent range rebalancing or interval rebalancing, rebalancing is triggered by changes in relative asset
values rather than simply by the passage of time.

corridor = T ± (P x T)

Question 4

31.f: Discuss the key determinants of the optimal corridor width of an 
asset class in a percentage-of-portfolio rebalancing program.

Answer 4

Tranaaction cost- Wider optimal width

Risk tolerance. Higher risk tolerance wider optimal widths

**Correlation of returns with other asset classes.** 
When asset class returns tend to move together, the impact of deviations from target 
allocations on portfolio risk are less. Higher correlations, therefore, suggest wider 
optimal corridors.

**Volatility of asset class returns**. Greater volatility of asset class returns make deviations from target weights 
potentially more costly and suggest narrower optimal corridor widths. 

**5. Volatility of the returns on the other assets in the portfolio. **Greater volatility of the returns on the other assets in a portfolio (viewed as a single asset for simplicity) also suggests narrower optimal corridor widths because
deviations from optimal weights can lead to even greater deviations when asset
returns are highly volatile.

Question 5

LOS 31.g: Compare the benefits of rebalancing an asset class to its target portfolio weight versus rebalancing the asset class to stay within its allowed range.

Answer 5

One rule that would accomplish this is to move the asset class weights halfway back to their target values.

if asset prices were trending higher, this
smaller adjustment would improve portfolio returns compared to reducing the allocation to the target weight of 30%

Question 6

LOS 31.h: Explain the performance consequences in up, down, and nontrending markets of 1) rebalancing to a constant mix of equities and bills, 2) buying and holding equities, and 3) constant proportion portfolio insurance
(CPPI).

Answer 6

Constant proportion portfolio insurance (CPPI): Under this strategy, target weight in equities varies directly with the difference between the portfolio value and some
minimum value. The difference is called the cushion

Question 7

31.i: Distinguish among linear, concave, and convex rebalancing strategies.

Answer 7

linear, concave, and convex refer to the relationship between portfolio returns and equity returns.

With a constant mix strategy, the reduction in the equity allocation as equity values increase reduces the increase in portfolio value compared to a buy-and-hold strategy and
produces the concave relationship

With a CPPI strategy, the equity allocation increases as equity values increase,
magnifying the impact of further increases in equities values. This strategy produces the
convex relationshi

Question 8

31.j: Judge the appropriateness of constant mix, buy-and-hold, and CPPI rebalancing strategies when given an investor’s risk tolerance and asset return expectations

Answer 8

It will underperform a constant mix strategy when equities values are volatile but not trending because portfolio value will simply oscillate around the initial value.

A buy-and-hold strategy will outperform a constant mix strategy when equities values are trending up or down because the percentage allocation to equities will increase when equities values are moving up and decrease when equities values are moving down

With a CPPI strategy the percentage portfolio allocation to equities increases when
equities values increase because the cushion increases and the multiplier is greater
than 1.

A constant portfolio proportions insurance strategy has a floor that is dynamically achieved, and fits the preferences of an investor who is concerned about downside risk
and has risk tolerance that increases more than proportionally to wealth, outperforms
the other strategies in both upward and downward trending markets, has a multiplier
(M) greater than one, and generates a payoff curve that is convex