Morningstar on Rebalancing and Emerging Markets

John Rekenthaler of Morningstar with some interesting thoughts on rebalancing of portfolios

....Implicitly, I've described mean reversion. Which is indeed what researchers find when documenting the behavior of financial markets. Although winners often remain winners over the short term, meaning for a few weeks or months, they tend to slide back when the time period extends past one year. Meanwhile, losers rebound. ....

Thus, it's sensible to rebalance assets that have similar risk levels. One example is different segments of the U.S. stock market, such as value versus growth and large versus small. Another would be between the stocks of different geographic regions, for example, the United States, Europe, and Asia. 

I would extend that advice to include developed-markets versus emerging-markets exposure. While emerging-markets stocks are certainly a riskier bunch, and thus should have superior long-term returns, it's not clear to me that the gap between the two groups is large enough to eliminate the benefits of rebalancing.

Also, the risk-on/risk-off trade that affects emerging-markets performance may be mean-reverting. Central bankers loosen their monetary policies, investors gain confidence and pursue riskier assets, emerging-markets securities flourish, central banks grow concerned about asset inflation and signal that they may tighten, investors become worried, they lose confidence and sell riskier assets, emerging-markets securities decline, central banks grow concerned about asset deflation and signal that they may loosen, and so forth. The theory is more anecdotal than proven, but it strikes me as provisionally correct.