Rebalance Timing Luck: The Difference between Hired and Fired

Prior research demonstrates that performance can be highly sensitive to index construction choices related to rebalance dates. The authors define the measure of rebalance timing luck as the standard deviation in returns between identically managed investment portfolios that are rebalanced on different dates (sub-indexes). Using a simple fixed-mix strategy, the authors identify that rebalance timing luck can have significant implications for realized results. Statistical tests imply that the ex ante expected returns for the sub-indexes are identical and that realized performance differences are not expected to mean-revert over time. The authors demonstrate that investors can minimize the impact of rebalance timing luck through equal-weight exposure to the sub-indexes. The authors propose an ex ante model to estimate the magnitude of rebalance timing luck and to confirm that the process of equal weighting across N sub-indexes reduces rebalance timing luck by 1/N. TOPICS: Mutual funds/passive investing/indexing, portfolio construction, performance measurement, statistical methods