Dynamic beta management: getting paid to manage risks

To improve governance through a disciplined and formal process, staff developed a series of rules that examined the valuation of assets based on specific economic factors and made the decision to be overweight or underweight within the ranges explicit and formal based on the recommendations of the rules. Therefore, if an asset was underweight and relatively undervalued (i.e., relative to other assets), the rules would recommend raising the weight in the portfolio and so on. Everyone knows the adage of “buy low and sell high,” but few have reliable indicators of what is low or high enough. Dynamic beta can provide an indication of the proverbial highs and lows as well as the pause required to wait for the next opportunity.



Many people will criticise this approach as being “market timing”; this naïve statement does not recognise that letting the portfolio drift or even blind rebalancing to the SAA on some set schedule is also market timing! Both these naïve strategies are market timing bets that are implemented with less analytical rigor or justification than the informed rebalancing approach.



The programme design aspects as laid out to the Board were as follows:



(a) rules developed by staff to tilt the beta of the portfolio were based on peer reviewed journal articles;



(b) the goal would be to achieve a positive excess return from informed rebalancing, relative to all other naive approaches;



(c) relative tilts would be limited to just assets in the SAA and the sum of the relative tilts would be zero. This applied to US stocks, International stocks and US bonds initially and later for currency, large capitalisation versus small capitalisation stocks, value versus growth stocks and credit versus core bonds;



(d) the tilts in any asset class would be limited to the ranges permitted by the Board;