London Market Monitor – 31 August 2022
Our August review of the markets and Solvency II discount rates.
Rebalancing strategies play an important role in ensuring asset portfolio continues to meet its stated objectives in volatile markets. In designing a rebalancing strategy, there needs to delicate balance between managing transaction costs and accurately implementing the objectives.
In this paper, we explore the concept of using a whole-of-portfolio risk-based measure to determine when rebalancing trades are triggered, as well as a transaction cost optimised approach when determining the instruments to trade. To illustrate the impact of this, we then compared the concept against more conventional rebalancing strategies on a typical dynamic hedging program for a Variable Annuity guarantee over backtested and simulated real-world scenarios.
We found that by limiting rebalancing trades to only when the whole-of-portfolio risk is material, we can significantly reduce the expected transaction costs whilst achieving a similar level of hedge effectiveness.