What triggers a benchmark rebalance?

We received an inquiry recently regarding the appropriateness to rebalance a benchmark when the portfolio has a 10% flow. I discussed this with my colleagues, and we were all a bit surprised by the question. Now, perhaps there are loads of firms that do this, and we're just not aware; or, the questioner was confusing rebalancing benchmarks with revaluing portfolios to calculate time-weighted returns (a common practice to revalue a portfolio when large flows occur). 

The benchmark represents the strategy. What should cause it to be rebalanced?

Well, let's consider the portfolio and benchmark at the start of investing. Let's make it really simple, and say that there are two asset classes, stocks and bonds, and that the strategy is to be 50/50 (i.e., 50% stocks, 50% bonds). Almost immediately, in response to market movements, both will drift from their initial allocation. And even though the strategy is 50/50, the portfolio may have a different one, based on tactical decisions of the manager; perhaps the manager decided to overweight stocks, so the portfolio begins at 60/40. 

And so, we see that they both drift. Let's project that stocks are doing much better than bonds, so that after a month the benchmark is 55/45 and the portfolio's at 65/35. Do we rebalance?

To rebalance the portfolio, the manager must sell some stocks (that appreciated) and put the money into bonds (which didn't do as well relative to stocks during this period). This trading is costly, yes?  Transaction costs (e.g., commissions) must be paid. A manager may elect to rebalance in order to reduce risk: while the portfolio benefited from the market, the farther away it goes from its initial target, the greater the portfolio's risk, should the market turn. And so, the manager may forgo further increases to the full amount currently sitting in stocks, in order to protect the portfolio from a jolt in the market. Some managers will allow the portfolio to continue to drift, however. Let's say that the manager does not, at this point, rebalance the portfolio; should they rebalance the benchmark?

Unlike rebalancing the portfolio, when we do this to the benchmark there is no cost; it's just making adjustments to the weights and calculating the appropriate return: no transactions are needed and no transaction costs are incurred. So, should the manager rebalance the benchmark?

There are at least two options:

#1 Since the portfolio is allowed to drift, to bring the benchmark back into alignment would create a situation where the portfolio is doing something the benchmark isn't allowed to do, and so perhaps it's gaining an advantage.

#2 HOWEVER, recall that benchmarks shouldn't include tactical decisions. In addition to an allocation that's different from the strategy, I'd say that to allow the allocation to drift (in response to the market) is also a tactical decision. Let's say that the equity portion continues to grow, and then BOOM, we get hit with a big market adjustment; the portfolio's return will drop. Well, if we allow the benchmark to drift, too, it will suffer from the same market downturn. But the benchmark is no longer the strategy, it's drifted away. And so, I would say that "best practice" would call for regular periodic rebalancing of the benchmark (most likely monthly), to ensure it remains representative of the strategy. 

And so, in answer to the question, "what triggers a benchmark rebalance," I would say time. 

Another component could be drift, right? The firm can establish a threshold that says if the benchmark's strategic allocation shifts by X% or more, it will be rebalanced. I'd think this would be fitting, too.

The benchmark is to align with the portfolio's strategy, and one would think that the rebalancing rules should be a component of the strategy: if it calls for quarterly rebalancing, then the benchmark should rebalance at the same point. If the manager decides to override the strategy and use a tactic to gain an advantage, then I would think the benchmark should continue with the strategy's  rules.

This is an area where I haven't done much dabbling, and so don't know what common practice is, or even if there is a "common practice," so am open to your thoughts, suggestions, ideas, etc. Thanks!