GLOBAL - Strategic and tactical asset allocation decisions are converging into "a more holistic process" as investors refine their risk management post-crisis, State Street says.
A strategic asset allocation is usually intended to remain fixed for a certain amount of time, but increased volatility in the markets means some investors are reviewing conducting more frequent risk analysis.
In a new report titled Rethinking Asset Allocation, State Street says investors are increasingly looking at their so-called horizon risk, the risk that asset classes will fall outside of their pre-determined allocation within the portfolio during the investment horizon.
"As a consequence, strategic allocation, normally associated with beta and long-term risk premiums, and tactical allocation, normally associated with the pursuit of alpha, are blending into a more holistic process. To effectuate this, investors are increasingly turning to global macro hedge funds, effectively outsourcing their tactical asset allocation," the report says.
In addition to horizon-risk, investors are increasingly looking at risks introduced through investment regimes and turbulence, says State Street.
"The emerging field of investor behavior examines the activities of investors in aggregate with a view to understanding their sentiment, particularly their tolerance for risk. Clustering this behavior into regimes makes clear that regimes dictate behavior and that this behavior has a quantifiable impact on asset-return characteristics.
A study of turbulence can also help investors know what to expect during certain market conditions.
"Turbulence may arrive randomly, but once it begins, it takes time to get through the systems. As markets encounter one of their 10% most turbulent days, the likelihood of that turbulence continuing over the next five, 10 or 20 days is substantially larger than during normal times," the report says.
The financial crisis has spurred a rethink of modern portfolio theory and its balance of risk and return assumptions that have driven portfolio construction for over 50 years.
"The financial crisis exposed the need to understand the limitations of traditional practices such as Modern Portfolio Theory, and heightened the need for new approaches to strategic and tactical asset allocation," said Dan Farley, global head of the multi-asset class solutions group at State Street Global Advisors.
"Thanks to lessons learned from this period, many investors have gained a more nuanced reminder of portfolio risks centering on market volatility, portfolio construction and trading liquidity."
Meanwhile, State Street Global Markets announced today the launch of a turbulence indices, a suit of indices that provide a daily measure of turbulence in market behavior.
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