Dynamic Strategies: Constant Mix

Posted By: Advisor Analyzer Team

As the old saying goes, there is more than one way to skin a cat. Similarly, there is more than one way to invest and maintain one’s investment portfolio. Anyone involved in the markets know that investment management is not a onetime event, but a dynamic process. An investor may buy and subsequently sell an investment when it does not perform as expected. Some may rebalance to maintain their initial allocation, and others may exercise a buy hold strategy. While it is difficult to determine which is best, we are able to distinguish the pro's and con's of each strategy.

Constant-Mix Strategy

The constant-mix strategy maintains equity allocations that are set at a constant fixed percentage of the total portfolio value.  Therefore, periodic rebalancing of the portfolio to return it to the initial desired asset allocation is required. The trading strategy is to purchase equities as they decline, and sell equities as they rise in value.

Payoffs:

Usually, this strategy offers relatively little protection from price declines, since the strategy entails purchasing more securities when prices fall. The strategy also underperforms in a rising price environment, since an investor must sell his positions to maintain the same allocation to equities.

Performs Best/Worst When:

The strategy performs best in a sideways moving (oscillating or volatile) market and effectively capitalizes whenever there are market reversals.  This is especially the case when equity values are in a period of high oscillation, but end close to their beginning levels. Therefore, greater volatility around the initial investment values amplifies the performance.

Ideal Investor for Strategy:

The constant-mix strategy is most appropriate for investors with varying risk tolerances in all proportions with wealth. Ideally, the investor is willing to maintain some equity exposure at all levels of portfolio value. However, the strategy also requires some predetermined rule regarding rebalancing. Traditionally, the constant mix approach avoids transaction costs until the value of a portion of the portfolio (or the portfolio as a whole) has changed by a predetermined barrier percentage.

Cost of Implementing Strategy:

Mainly, transaction costs are incurred only when rebalancing takes place. When all assets move synchronously, rebalancing is not required and transaction costs are avoided. Taxes can be a considerable cost for taxable investors. 

Conclusion

There are many more portfolio strategies available to investors, but the Buy Hold, Constant Mix, Constant Proportion strategies are most often used by financial professionals today. Investors that properly utilize the correct strategy for a given market environment can claim superior portfolio performance over their investing peers who practice a wrong strategy. However, no single strategy can claim absolute superiority to another at all times, since each strategy has its unique merits and shortcomings in skinning the financial cat.