Diversification Return, Portfolio Rebalancing, and the Commodity Return Puzzle

14 Pages Posted: 31 Jul 2011

See all articles by Scott Willenbrock

Scott Willenbrock

University of Illinois at Urbana-Champaign

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2010


Diversification return is an incremental return earned by a rebalanced portfolio of assets. The diversification return of a rebalanced portfolio is often incorrectly ascribed to a reduction in variance. We argue that the underlying source of the diversification return is the rebalancing, which forces the investor to sell assets that have appreciated in relative value and buy assets that have declined in relative value, as measured by their weights in the portfolio.

In contrast, the incremental return of a buy-and-hold portfolio is driven by the fact that the assets that perform the best become a greater fraction of the portfolio. We use these results to resolve two puzzles associated with the Gorton and Rouwenhorst index of commodity futures, and thereby obtain a clear understanding of the source of the return of that index. Diversification return can be a significant source of return for any rebalanced portfolio of volatile assets.

Suggested Citation

Willenbrock, Scott, Diversification Return, Portfolio Rebalancing, and the Commodity Return Puzzle (December 1, 2010). Financial Analysts Journal, Vol. 67, No. 4, pp. 42-49, July/August 2011, Available at SSRN: https://ssrn.com/abstract=1898864 or http://dx.doi.org/10.2139/ssrn.1898864

Scott Willenbrock (Contact Author)

University of Illinois at Urbana-Champaign ( email )

1110 West Green Street
Urbana, IL 61801-3080
United States

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