Rebalancing Your Portfolio? Active Money Managers Outline New Approach

portfolioNow that the market rebound has restored a portion of their portfolios, many buy-and-hold investors who took losses during the 2008 market crash are looking for proactive ways to prevent a repeat of that ordeal. A new approach to tactical investing that follows the lead of some of the top active investment managers in the country may help.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% William Hepburn, CEO of Hepburn Capital Management, is advancing a concept called "Adaptive Rebalancing," which says investors should rebalance their portfolios each quarter using the average stock allocation of members of the National Association of Active Investment Managers (NAAIM). In a study he conducted, a portfolio based on the allocations of NAAIM members, who are hedge fund, mutual fund and separate account managers, produced investment returns that outpaced the traditional 60/40 mix of stocks and bonds many investors use when rebalancing.

NAAIM managers currently have an average portfolio allocation of 54.96% equities and 45.04% bonds for the fourth quarter 2009, demonstrating that they believe stocks are trending up. The new Adaptive Rebalancing allocation for first-quarter 2010 will be available on the Hepburn Capital website on Jan. 4.

"The NAAIM managers are active managers, and they will tend to get out of the market much more quickly than others," says Hepburn. "They don't just look at the market and hope it recovers. They take action when the market tells them that a certain trend is emerging."

"Better in Down Markets Than Up Markets"

Hepburn contends that NAAIM members were ahead of the downward market trend that started in 2008. He said a portfolio using the average of NAAIM members' allocations produced a gain during the fourth quarter of 2008 as the market was crashing. And when the stock market was at its lowest point in March of 2009, NAAIM managers on average had about 28% of their holdings in stocks -- allowing them to limit losses. He also conducted a study of S&P 500 market returns from Sept. 30, 2006 to Sept. 30, 2009, which showed a portfolio composed of the traditional 60/40 stock/bond mix produced a loss of 0.56% versus a gain of 9.06% for a portfolio using the average allocation of NAAIM members and Adaptive Rebalancing.

While his study produced strong returns, Hepburn admits results rely heavily on how the bond portion of the portfolio is invested. And he doesn't guarantee positive results every quarter, either. Of the 12 quarters in his study, six had positive returns, and six were negative. He will only say that for investors who can rebalance their portfolio four times a year (rebalancing non-tax-deferred accounts can have expensive tax consequences), using Adaptive Rebalancing "will work better in down markets than up markets," and it "lowers the risk of getting caught in another big decline."

For some, Hepburn's approach will sound a lot like trying to time the market. "I favor a strategic long-term approach [to rebalancing] because investors oftentimes don't time their maneuvers properly," warns Christine Benz, director of personal finance for Morningstar.

Not Perfect but Perhaps Reasonable

Benz also says she favors a rebalancing approach where "you rebalance only when you get significantly out of balance with your allocation targets." That's not likely to happen four times a year, so investors might want to consider if it's worth rebalancing if their portfolio is not significantly out of balance. And since every investor's allocation targets will be different, the average equity/bond allocation of NAAIM members may not correspond to the needs and goals of every investor, particularly those closer to retirement who may need to be a bit more conservative with their allocations to stocks.

While it is not perfect, Adaptive Rebalancing may still seem like a reasonable way to tap into the expertise of active money managers in an attempt to improve returns. Investors who have suffered significant losses may want to see how it works for them.
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