The Cost of Chasing Sleeve Performance
Reallocating capital toward whichever strategy sleeve performed best recently, and away from whichever performed worst, tends to systematically buy each sleeve near its peak and sell it near its trough, since strategy performance is streaky but not usually predictive of what comes next.
A multi-strategy portfolio manager watching each sleeve's recent returns will naturally feel the pull to shift capital toward whichever sleeve has been performing well and cut whichever has been struggling. This is the same performance-chasing behavior well documented among retail fund investors, just moved one level up to allocating between internal strategies instead of between external funds — and it suffers from the same problem. Most strategies' short-term performance is dominated by noise or by temporary factor tailwinds rather than a persistent change in underlying skill, and factor and strategy performance tends to mean-revert over medium horizons rather than trend. Chasing recent winners therefore tends to increase allocation right as a sleeve's edge is fading and cut allocation right as a struggling sleeve is about to recover.
The discipline that avoids this is a pre-committed rebalancing rule — reviewing allocations on a fixed schedule against a fixed set of criteria decided in advance, rather than reactively after any particularly good or bad stretch — so allocation decisions aren't driven by whichever sleeve happens to be having a hot or cold month right now.
A worked example
If a manager cuts a value-strategy sleeve's allocation in half after two rough quarters and moves that capital into a momentum sleeve that just had two strong quarters, and value then mean-reverts upward while momentum gives back its recent gains, the manager has captured the worst of both moves — exactly the pattern seen repeatedly in fund-flow studies of investors chasing recent fund performance.
Shifting capital toward recently outperforming strategy sleeves and away from recently underperforming ones tends to buy high and sell low at the sleeve level, because short-term strategy performance is largely noise; a pre-committed, schedule-based rebalancing rule guards against this bias.
Related concepts
Practice in interviews
Further reading
- Grinold & Kahn, Active Portfolio Management, ch. 6