Calendar rebalancing vs. percent-range rebalancing — pros, cons, and when to use each?

Rebalancing is a crucial implementation topic in Level III. Here's the comparison: **Calendar Rebalancing** - **How it works:** Rebalance to target weights on a fixed schedule — monthly, quarterly, or annually. - **Advantages:** - Simple to implement, easy to communicate to governance committees - Lower monitoring costs - Predictable transaction timing (can batch with other trades) - **Disadvantages:** - May rebalance when unnecessary (if weights haven't drifted much) - May miss significant drift between dates (e.g., a market crash mid-quarter) - No responsiveness to market conditions **Percent-Range (Corridor) Rebalancing** - **How it works:** Set trigger points (corridors) around each target weight. Rebalance only when an asset class drifts beyond its corridor. E.g., if target is 60% equities with a ±5% corridor, rebalance when equities drift above 65% or below 55%. - **Advantages:** - Only trades when needed — more cost-efficient - Captures significant drift promptly - Theoretically superior risk control - **Disadvantages:** - Requires continuous monitoring - Corridor width decisions are subjective - Can trigger frequent trades in volatile markets (higher costs) **Setting Corridor Width — Key Factors:** Wider corridors are appropriate when: - Transaction costs are high - Asset class has high correlation with the rest of the portfolio - Taxes on rebalancing are significant - The investor has high risk tolerance Narrower corridors when: - Transaction costs are low - Asset class has high volatility (bigger drift risk) - The asset is weakly correlated with the portfolio (drift means more risk change) - The investor has low risk tolerance **Example:** A pension fund with a 40% allocation to emerging market equities (high volatility, high transaction costs). You'd set a relatively *wider* corridor (say ±7%) because the cost of frequent rebalancing outweighs the benefit. But for a 30% allocation to US treasuries (low cost, low volatility), a *narrower* corridor (±3%) is appropriate. **Exam Format:** Expect vignettes asking you to recommend corridor widths for different asset classes within the same portfolio, or to compare a calendar approach vs. corridor approach for a specific investor. Practice rebalancing scenarios in our CFA Level III question bank.