Regime Change: Implications of Macroeconomic
Shifts on Asset Class and Portfolio Performance

Abstract

It is a well-recognized empirical observation that different asset classes respond differently to different economic drivers. It is also well recognized that asset class behavior can vary significantly over shifting economic scenarios. This article builds on this empirical evidence to develop a quantitative framework for regime-based asset allocation. It investigates whether regime-based investing can effectively respond to changes in economic regimes at the portfolio level in an effort to provide better long-term results when compared to a more static approach. Results indicate that it is both possible and practical to develop a regime-based investing approach that can potentially add value over time. Success depends on identifying key factors that influence asset class performance, and then developing a way to model those non-linear relationships. Regime-based investing also requires a healthy degree of economic forecasting skill, which need not be perfect to add value. Based on the authors’ analysis, regimebased investing can offer investors a compelling alternative to a more static approach.

TOPICS: Portfolio construction, factor-based models, real assets/alternative investments/private equity