Optimizer > Rebalancing > Rebalancing Test

Rebalancing Test

Optimizer Help Documentation

Rebalancing should only take place when the optimal portfolio is testably distinct from the current allocations. This policy limits unnecessary trades and their attendant costs. New Frontier's second patented process, the rebalance test, helps you determine when rebalancing is necessary.

The underlying theory for the calculations appears in "Portfolio Monitoring in Theory and Practice" (Journal Of Investment Management Q3 2012, available in draft form on the New Frontier website).

Rebalancing Section of the Ribbon

The rebalance button opens a drop down menu. It is only available after optimization has taken place.
- Rebalance uses the inputs and selected optimization options to make the intermediate calculations for testing the calculated optimal portfolios' need to rebalance. After optimization has taken place, results of these intermediate calculations are necessary in order to run any rebalance test. However, it is possible to load a pre-calculated set of intermediate calculations (relative variances) from a previously saved .nfrv file. How much time the procedure will take depends on the selected options, particularly the rebalance simulations and meta-simulations settings (see below). A progress bar appears to show how much time for this step to complete. The procedure can be interrupted by clicking the Stop Button on the progress bar window.
- Rebalance Portfolios uses previously run rebalance test intermediates to calculate rebalance tests for new or modified reference and initial portfolios. By not repeating the intermediate calculations the tests can be run much more rapidly. This procedure is only available when you make changes or add to the reference portfolios without changing anything else in the case, or load a set of relative variances in a .nfrv file. This option allows you to bypass many time-intensive calculations by calculating the rebalance score for the reference portfolios.
Typical Rebalance Period refers to the number of periods of new information introduced into the analysis between typical trades or rebalances. Information can be introduced into an optimization in many ways: additional historical data, new forecasts, changes to constraints, etc. Because of the variety of forms this information takes, the number entered into this field is simply a heuristic measure of the amount of new information that would typically trigger a rebalance. Aggressive portfolio managers normally use a small number in this field as they likely rebalance portfolios frequently, whereas more passive (or possibly tax-aware) managers would chose a larger value to trigger rebalancing less frequently. If you enter nothing in this field, the rebalance test assumes total information turnover between rebalances and will produce relatively small rebalance probabilities. The total number of periods in each dataset is determined through the forecast confidence.
Rebalance Simulations controls the number of simulations tested. If no number is entered, the rebalance test uses all of the simulations calculated during optimization. This is the recommended option for actual use and the default choice. If a faster rebalance is desired, decrease the number of simulations used by entering a number less than the number in the Optimizer Simulations Field further along the ribbon. This can be useful for setup and testing purposes. Note that if the number of optimization simulations is set to N/A, thereby enabling optimization tolerance, the number of rebalance simulations cannot be N/A, so the Optimizer replaces N/A with "500" automatically though a larger number can be set. The number of realized simulations in the optimization is shown on the Info Worksheet.
Meta Simulations controls the precision of the rebalance test calculation. In meta simulation, a Michaud Efficient Frontier is calculated for each rebalance simulation. Our research shows that rebalance test scores may rise with more simulations, so make sure that tests are run with meta-simulations set to standard or refined if rebalance tests scores are near the cutoff for rebalancing.
- Quick creates each frontier from twenty simulations. It is useful for a quick, but imprecise answer.
- Standard creates each frontier from one hundred simulations. This runs quite slowly, so we recommend employing additional cores to assist the computation. This option is the recommended option in most situations.
- Refined runs five times as many simulations as the Standard option, running five times slower as well. It is best used as a final run to tighten up any Monte Carlo error.

Rebalance Probability (Results)

The rebalance probability or score is a comparison of the distance (tracking error/relative variance) between one portfolio and an optimal portfolio to the distances of statistically equivalent alternative optimal portfolios from the same optimal portfolio. Specifically, the rebalance probability is the rank of the distance of the initial portfolio from the optimal, among the distances of the optimal portfolio from a set of meta-resampled (statistically similar) optimal portfolios with the same portfolio rank, or the same filter score if filter matching is enabled. A rebalance score of 100% means that all of the portfolios simulated during the rebalance test fall closer to the target optimal portfolio than the portfolio with the 100% rebalance probability does, which is quite strong evidence that the portfolio is not optimal, at least for the targeted risk or return as indicated by the selected optimal portfolio in the rebalance test. As the rebalance probability decreases, the two portfolios become closer to one another. So, a high rebalance percentage indicates that rebalancing could be beneficial. The Optimizer highlights especially high rebalance probabilities, above 80%, by coloring the selected portfolio's rebalance probability red on the Results Worksheet. Similarly, green signals an especially low rebalance probability in which rebalancing is unlikely to be helpful, from a statistical perspective.

Viewing Results

The rebalance probability appears in charts and tables:

The Rebalance Probability row in the Results Table displays the initial portfolio against the selected optimal portfolio. Be aware that if you don't load an initial portfolio, the Rebalance Probability row populates with 100% across the board.
The table at the top of the Charts Worksheet shows the rebalance probability according to what is selected in the Portfolio 2 drop down menu. This is the only way to view the rebalance score for reference portfolios.
The Rebalance Probability Chart, available on the Charts Worksheet and Rebalance Worksheet, provides a visual representation of the rebalance probability across the optimal efficient frontier in regard to the initial portfolio or selected reference portfolio.
The Efficient Frontier Chart on both the Results and Charts Worksheets can display the rebalance probability of the initial portfolio across the efficient frontier if the appropriate box is checked. The meta-resampled simulations appear in purple on the chart after you run the rebalance procedure if you check the RE Simulations option.

Trade Advisor works with the rebalance test to help you decide how to trade if a full rebalance to optimal is undesirable. This feature can ensure that a low rebalance score is maintained under partial trading.