Episode 5: The Rebalancing Premium
Lesson summary:
The lesson discusses the importance of diversification and the number of independent bets in a portfolio. They emphasize the potential benefits of maximizing diversification, particularly in the commodity space, to generate a rebalancing premium. By constructing a well-diversified portfolio with multiple independent bets, investors can potentially achieve a three to four percent annual excess return through rebalancing. The hosts highlight the limitations faced by larger institutions in accessing this premium due to market capacity constraints. They also emphasize the need to prepare for various types of inflation shocks through a maximally diversified approach. The episode concludes by discussing the challenges of introducing tilts or deviations from maximal diversification, as it introduces volatility drag and requires a higher hurdle for returns.