What are the portfolio construction differences between equal-weighted and capitalization-weighted with regard to terms like reconstitution and rebalancing?

Reconstitution seems very straightforward. In any portfolio structure, reconstitution occurs based on your criteria and securities are removed or added to your portfolio.

My interpretation of rebalancing is not so good. Say you are looking at monthly returns, rebalance quarterly, and have two securities with weights $(0.2, 0.8)$. In each month, there will be market fluctuations and these initial weights will deviate. At the end of each month, would you maintain the $(0.2, 0.8)$ weights by selling off winners and buying losers? Or would you only do this at the rebalance period (let weights float until rebalancing)? If the portfolio is equal weighted with weights of $(0.5, 0.5)$, would you maintain the equal weights each month (by selling winners and buying losers) or only adjust at the rebalance period?

  • 3
    $\begingroup$ it depends on the index you're tracking. if the index is cap weighted, then you want your portfolio to be cap weighted. if it's equally weighted, then you want your portfolio to be equally weighted. how frequently you rebalance, depends on how closely you want to track the index. if you want to track it closely, you need to rebalance more often. ( but watch out for transaction costs ), if you want to track it less closely, then you can afford to rebalance less frequently. But i whether you do cap weighting or equal weighting is not up to you because that's a characteristic of the index itself. $\endgroup$
    – mark leeds
    Sep 1 at 23:49
  • $\begingroup$ @markleeds makes sense. I'm still unsure what simply a portfolio that "rebalances quarterly" means. Do you let weights float or adjust them to their weights in each period? $\endgroup$
    – Jason p
    Sep 2 at 0:47
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    $\begingroup$ Yes, quarterly rebalance means you only buy/sell shares to bring weights back to desired values once a quarter. $\endgroup$
    – noob2
    Sep 2 at 9:01
  • $\begingroup$ @Jason p I haven't heard of a mandate such as "quarterly rebalancing" but I guess it could be something decided on between investor and portfolio manager and written up in the investment agreement ? Most portfolios that track an index would be rebalanced whenever the weights of the portfolio became very different from the index weights. What "very different" means would usually be decided by portfolio manager since it's his job to track the index as closely as possible. $\endgroup$
    – mark leeds
    Sep 3 at 1:46
  • $\begingroup$ @markleeds totally agree with your description of the necessity of conforming to index composition $\endgroup$
    – Jason p
    Sep 3 at 1:52

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