The Prisma platform helps investors to better manage market extremes and offers risk indicators that enable them to manage their equity exposure and generate consistent and robust returns.

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In this article we will show how a single indicator, the Equity Risk Indicator (ERIC), can be used to develop different strategies adapted to each investor in terms of rebalancing frequency. We will apply this indicator to a portfolio of S&P 500 Index ETF (SPY:US) and USD Cash.

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Rebalancing parameters

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In the advanced settings of each indicator, it is possible to choose two parameters to adjust the rebalancing frequency:

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1. the rebalancing frequency (quarterly, monthly, etc…).
2. the threshold value for the rebalancing of the indicator. Let’s assume that this threshold is 25%. This means that after a rebalancing, another rebalancing is triggered if the indicator moves by more than 25% since the last rebalancing.

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These parameters have a direct influence on the sensitivity of the portfolio allocation and the frequency of rebalancing. Below is a screenshot of the indicator’s settings.

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Turnover and performance

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Let’s first compare two strategies with a threshold of 25% and different rebalancing intervals, monthly and quarterly.

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We see that monthly or quarterly rebalancing leads to similar performance with the same maximum drawdown and a slightly better Sharpe ratio in the quarterly rebalancing scenario. In the case of monthly rebalancing, the strategy requires 17 rebalancings per year, while the others require 10 on average.

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If 10 rebalancings are still outside the comfort zone of portfolio managers, it is possible to further reduce the number of rebalancings by increasing the rebalancing threshold. To illustrate this, we add strategies with a higher threshold of 50%, making portfolio rebalancings less sensitive to small fluctuations in risk indicators.

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The robustness of the ERIC indicator makes it possible to maintain performance while greatly reducing the number of rebalancings per year. The strategy with quarterly regular rebalancing and a 50% threshold only needs to rebalance five times per year on average and still achieves a return of 9.0% and a Sharpe Ratio of 0.72. The maximum drawdown is -18.7%, compared to -14.6% for the previous 25% threshold and -51.5% for passively holding the SPY ETF. Thus, an investor or institution wishing to reduce the frequency of rebalancing can choose a quarterly rebalancing and a higher threshold to retain the added value of the ERIC indicator for their portfolio. We encourage every investor to test the contribution of the ERIC indicator to their own asset allocation on Prisma.

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Disclaimer:

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This content is advertising material. This content as well as all information displayed on Prisma or any of Alquant’s websites does not constitute investment advice or recommendation, and shall not be construed as a solicitation or an offer for sale or purchase of any products, to effect any transactions or to conclude any legal act of any kind whatsoever. Past performance is not a guide to future performance.