from Rebalance Frequency Drift Exceeds Absolute Active Return Quarterly 14% Semiannually 24 Annually 39 Biannually 50 strategy, the returns to the strategy appear to be zero or slightly negative. Across hundreds of simulations for a variety of benchmarks and rebalance frequencies, we find the average return is about -5 basis points per year. But these averages mask the highly visible and important periods where asset allocation drift is much worse. Consider a 60/40 plan with no asset allocation drift at the beginning of 1987. This plan would have entered October 1987 with a 7 percent stock overweight, resulting in an additional 1.4 percent loss in October 1987. The Long Term Capital Management (LTCM) blowup of 1998 and September 11, 2001, events created similar impacts on portfolio performance from not rebalancing. Of course, drift risk isn't the only cause of asset allocation risk. Cash sitting in managers' accounts, currency deviations driven by stock selection activities, and manager or benchmark transitions also create unintentional risk that is frequently left unmanaged. The solution to controlling these risks for larger plans is a completion manager. A completion manager coordinates the portfolio's overall asset allocation and is charged with explicitly minimizing unintentional asset allocation risk. Complex schemes with frequent cash flows may use their custodian as a specialized completion manager given their proximity to the information flows in the portfolio. The ideal method for implementing a completion strategy is through liquid equity index futures, bond index futures, and currency forwards. This approach is optimal due to the ease of trading and low transaction costs. Currently, there are approximately 40 global index securities that are liquid enough for completion strategies. To indicate the magnitude of cost savings, for a normal trade size of $5 million, the cost of trading equity index futures is approximately 90 percent less than an equivalent trade in physicals. These derivatives also make it possible to manage the completion portfolio with limited capital due to the minimal margin and collateral requirements. (See Chapter 25 for further discussion on futures implementation issues.) These arguments strongly favor the use of liquid derivatives to implement a completion strategy, but a rebalance strategy may also be implemented using cash instruments, with a natural reduction in efficiency. For example, some institutions use so-called "swing" portfolios.6 A swing portfolio generally requires a substantial carve-out, often 10 to 20 percent of the overall portfolio. This capital is typically invested in index funds to bring the overall portfolio back toward its strategic 6The swing portfolio approach is much more common in Japan than in the United States.