The strategy utilizes the idea of a Rebalancing premium introduced by Willenbrock (2021). The paper argues that a simple buy-and-hold portfolio does not earn a diversification return. However, it generally has a lower variance than the weighted-average variance of its constituents. The cumulative return of a buy-and-hold portfolio is driven by the assets that perform the best and thus become a greater fraction of the portfolio. On the other hand, Willenbrock suggests the existence of a premium in a periodic rebalancing of uncorrelated assets. Additionally, the author emphasizes that reducing variance in a diversified portfolio is a necessary but not sufficient condition to earn a diversification return.

Novel research further analyzes the rebalancing premium on the cryptocurrency market. The study found a significant premium in the periodic rebalancing of cryptocurrencies. Moreover, the paper compares the daily-rebalanced long-only portfolio to the long-short portfolio with various weights on the short side. Additionally, the paper analyzes the ability of the rebalancing premium of cryptocurrencies to improve the performance of low volatile assets such as bonds.

Rebalancing premium is defined as the premium an investor gains from periodically rebalancing their portfolio. For example, imagine having two assets with zero return and high volatility. If we buy just one, we are not going to earn anything. However, buying both and periodically rebalancing forces the investor to buy the asset that has decreased in relative value and sell the asset that has appreciated (thus taking profit) in relative value (as measured by their weights in the portfolio). As a result, the investor earns a so-called “rebalancing premium” or “diversification return.”