Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. INVESTING & PORTFOLIO STRATEGIES
February 13, 2017 12:00 AM

Adaptive regime-based approach to multiasset class investing

John Balder
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print
    John Balder

    Rules-based adaptive approaches to multiasset-class investing can be designed that protect investors from potentially devastating losses while participating when market conditions are more favorable. Such an approach is intended to adapt to shifts in risk appetite, financial markets and the real economy. Based on history, all of us know that markets do not behave “efficiently” at all times. Sometimes investors benefit from owning risky assets (e.g., equities, real estate investment trusts, commodities, high-yield bonds and emerging market debt), while at other times (think 2008) holding these assets generates significant losses.

    A first step toward developing this framework is to examine the history of annual returns, risks and correlations for a series of asset classes. These asset classes include equities, bonds, commodities, REITs and cash. A second step is to identify the macroeconomic and financial market factors that favor or work against each of these asset classes. In our opinion, these factors comprise the following data series: (1) measures of market sentiment, (2) interest rates, (3) household and business balance sheets, (4) real economic factors and (5) asset prices.

    To illustrate how one might design this framework, in the chart below we construct a simplified regime framework that uses three data series: GDP, the VIX and the S&P 500. The chart below standardizes and plots quarterly data for these three indexes.

    In this chart, we discern key relationships. Namely, when GDP growth is strongly positive and the "fear index" (the VIX) declines, the S&P 500 index generally increases in value. However, when the VIX increases and GDP growth slows, the S&P 500 tends to decline in value (the tech bubble in 2001-'02 and the financial crisis in 2008). A regime framework can be constructed that adapts to these changes in market conditions.

    This data can be segmented using a statistical process that generates a framework consisting of five regimes. These are labeled: (1) safety, (2) add risk, (3) adjust risk, (4) fade risk and (5) neutral. The table below ranks the Sharpe ratios by regime for the 10 asset classes using historical returns since 1990.

    Exhibit 2: Rankings by Sharpe Ratio by regime, 1990-2016

    RankingSafetyRisk-on!Adjust riskFade riskNeutral
    1GOLDEMBEMEUSEQCMDTY
    2USTHYEAFEEMBHY
    3TIPSEMEHYREITUSEQ
    4EMBREITGOLDHYEMB
    5REITUSEQUSEQEAFETIPS
    6HYUSTEMBCMDTYREIT
    7USEQGOLDREITTIPSEAFE
    8EMEEAFECMDTYUSTEME
    9EAFETIPSTIPSEMETIPS
    10CMDTYCMDTYUSTGOLDGOLD
     
       Positive Sharpe Ratio
       Negative Sharpe Ratio
     Notation:

    USEQ = US Equities;

    EAFE = Europe, Australia and the Far East Equities;

    EME = Emerging Market Equities;

    REITS = Real Estate Investment Trusts;

    CMDTY = Goldman Sachs Commodity Index;

    UST = US Treasuries;

    HY = High Yield Bonds;

    TIPS = Treasury Inflation-Protected Securities;

    EMB = Emerging Market Bonds;

    Cash = three-month T-Bills.

    Our process utilizes index exposures in combination with relevant Exchange Traded Funds (ETFs), to the extent available.

    The next step is to allocate the portfolio, which can be accomplished by imposing some rules. For example, the allocation can be determined by dividing the historic Sharpe ratio for each asset class by the sum of all Sharpe ratios for asset classes in that particular regime. If U.S. equities has a Sharpe ratio of 0.50 and the total for all Sharpe ratios in that regime is 2.50, the U.S. equity allocation would be 20%.

    In addition, these rules should factor in valuations. For example, an adjustment factor can be applied to the Sharpe ratio for an asset class if it is over- or undervalued. And there may also be reason to hold a cash allocation in a specific regime (e.g., safety), given opportunity costs and other considerations. Implementation of the portfolio can be achieved using highly liquid, low cost exchange-traded funds.

    Importantly, proper regime segmentation will drive success or failure. In the safety regime, only gold and U.S. Treasuries generated positive performance. Alternatively, in the risk-on and adjust-risk regimes, virtually all asset classes generated positive performance. In applying this process to history, it is important to see clear distinctions between the various regimes. If they all perform more or less similarly, this will defeat the intended performance objective, which is to capture periods of under and outperformance.

    Conclusion

    An adaptive, regime-based framework, if properly constructed, should provide protection in years such as 2008, while adding value when market conditions are more favorable. This framework should be designed to capture the evolving relationship between the real economy and the financial markets. Given the uncertainty that exists about future market performance, an adaptive approach offers a very sensible investment alternative to a broad swathe of investors, who seek to add incremental value while protecting capital.

    John Balder is co-founder of Investment Cycle Engine Inc., Newton, Mass. This content represents the views of the author. It was submitted and edited under P&I guidelines, but is not a product of P&I’s editorial team.

    Related Articles
    In pursuit of the holy grail
    Managers preparing for multiasset growth
    Consultants increasingly step onto managers' field
    Managers gently slipping into active equity territory
    Greenwich Associates: Active management will survive but shakeup is expected
    Managers question if passive effect on volatility
    Dip in volatility stirs warnings about too much complacency
    Recommended for You
    More funds testing water on crypto-related assets
    More funds testing water on crypto-related assets
    Money managers eager to make leap to opportunity zone investing
    Money managers eager to make leap to opportunity zone investing
    Index investing: Not as passive as you might think
    Index investing: Not as passive as you might think
    Emerging Markets: A Selective Approach
    Sponsored Content: Emerging Markets: A Selective Approach

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit