Regime-Based Strategic Asset Allocation
Eric Bouyé and Jerome Teiletche (World Bank)
April 2024
What should investors do in the presence of economic regimes? Researchers and practitioners usually address this topic from a tactical asset allocation point of view. In this article, we depart from the literature by tackling the issue strategically and analytically. Modeling economic regimes as a mixture of distributions, we first investigate what happens to moments of the distribution of returns. We next deduct the implications for portfolios built under popular asset allocation methodologies (mean-variance-optimization, risk budgeting). Using these analytical results, we define new portfolio construction methodologies seeking to exploit the information in macroeconomic (macro) regimes through the composition of optimal portfolios for each regime, the risk structure of these portfolios, and the long-term probability of the regimes. We empirically show that macro regime-based portfolios can outperform traditional asset-based portfolios, for both multi-asset and equity factor universes, over a sample of more than fifty years.
