Should the Interest Rate Level Influence Asset Allocation?

Abstract

How does the interest rate environment inform the allocation between risky and safe assets? The authors focus on the level rather than change in rates because rates are highly persistent; changes are infrequent and unpredictable while low versus high rate regimes are durable. U.S. history from 1926 through 2016 shows that equities have lower risk and higher excess returns when rates are low. Despite all the concern about low yield, a low rates environment is actually a good thing for more-aggressive investors.

TOPICS: Legal/regulatory/public policy, portfolio construction