Traditional multi-asset (stock/bond) index funds have fixed benchmarks of something like 60/40. While this creates a simple rebalancing strategy there is very little sense in rebalancing back to a fixed weighting in a multi-asset portfolio because the underlying market caps are so dynamic. For instance, a true "passive" multi-asset index
fund should have a dynamic relative weighting between stocks and bonds since the actual market caps change so much from year to year. But most multi-asset indexing methodologies apply a fixed weighting in their stock/bond weights and always rebalance back to this weight regardless of how the actual underlying market caps change. This means you're always rebalancing back to a higher stock market weighting when the stock market booms thereby resulting in the potential for excessive stock market risk at the worst possible times. This makes no sense! Countercyclical Indexing solves this problem by applying a tax and fee efficient indexing methodology that removes some of the procyclical tendencies from traditional rebalancing methodologies thereby better aligning a portfolio's asset allocation with the way we actually perceive risk.
In essence, Countercyclical Rebalancing is a strategy that rebalances its investments to reduce the pro-cyclical nature of the stock/bond weighting and help establish better balance across time. We achieve this by adjusting a portfolio’s holdings to account for the actual changes in market cap and macroeconomic conditions. In contrast, a standard passively-managed fund will generally hold stocks and bonds in the same percentage allocation (e.g., a standard 60/40 portfolio) regardless of market cap changes, market valuations and macroeconomic conditions. The problem with a fixed approach like this is that it assumes that the 60% stock allocation is always exposed to the same amount of risk, when, in reality, we know that can vary over time. For example, a portfolio with 60% stocks in 2008 faced very different risks than a portfolio with 60% stocks in 2010 and while this approach may be perfectly fine for many investors it may also pose significant behavioral risks to investors who think they're buying a "balanced" fund that actually has very unbalanced exposure to stock and bond risk.
The Discipline Fund rebalances more dynamically than a static fund does which allows the fund to rebalance toward stocks when they appear more attractive and away from stocks when they appear less attractive. This helps better control for behavioral biases by aligning our asset allocation to the potential behavioral risks that the ups and downs of the market expose us to.
Read our white paper on Countercyclical Indexing here