Using Value at Risk to Enhance Asset Allocation in Life-Cycle Investment Funds

Abstract

This article presents a straightforward approach to incorporate a Value at Risk (VaR) constraint into the asset allocation mechanism of life-cycle investment funds. It makes use of tactical tilts in asset allocation which take into account current market conditions, risk tolerance, and time to retirement. The attractive feature of this strategy is that it is easy to implement and does not require assumptions about the distribution of returns or estimating investor’s utility function. It also has the potential to deliver significantly higher terminal wealth to fund participants than present life-cycle asset allocation strategies.

TOPICS: VAR and use of alternative risk measures of trading risk, long-term/retirement investing, portfolio management/multi-asset allocation