Frank J. Jones

Determinants of Tracking Error for Equity Portfolios

The theoretical and empirical literature in finance has focused primarily on the standard deviation of return as the appropriate measure of risk. Yet for asset managers whose benchmark is a market index, the more appropriate measure is tracking error (the standard deviation of the difference in the portfolios returns and the benchmarks returns). For an asset manager, the risk of significantly underperforming the benchmark rises as the tracking error increases. Thus tracking error is an important indicator of portfolio performance and should be monitored frequently. The determinants of tracking error for equity portfolios include number of stocks in the portfolio, portfolio market capitalization and style difference relative to the benchmark, sector deviation from the benchmark, benchmark volatility, and portfolio beta.

Rebalancing Strategy for Stocks and Bonds Asset Allocation

This study examines the investment strategies of stocks and bonds portfolios under volatile markets. We find that the portfolio with rebalancing outperforms the portfolios without rebalancing. It also outperforms the portfolios with undiversified investments consisting of stocks only or bonds only. Specifically, the fifteen percent up or down rebalancing threshold on a 60% stocks and 40% bonds initial portfolio offers the best relative returns to risk. We find that fifteen percent rebalancing is also superior under both the lump-sum and the dollar-cost averaging investment modes. The optimal rebalancing strategies depend on the path of the market movements. Investors need to rebalance their asset allocations, but not frequently.