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White papers

Regime-cognisant asset allocation

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Regime-cognisant asset allocation

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Regime-cognisant asset allocation


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Executive Summary

Varying economic conditions have a direct impact on individuals, businesses and asset classes and so ultimately also impact an investment portfolio. Traditionally, when it comes to portfolio construction and asset allocation, the impacts of different economic conditions – referred to as regimes – are rarely considered, and could lead to an inefficient asset allocation across economic cycles.

Studies have shown that traditional strategic asset allocation approaches fall short of meeting investors’ expectations, and that asset class diversification alone is not sufficient as a risk mitigation strategy. This is mainly because certain regimes cause implicit deviations from the expected outcomes of a simple asset allocation strategy. Thus, an ideal investment portfolio could consider the differing impacts of each regime, and alter allocations preceding entry into the upcoming regimes.

We consider the effects of four regimes, namely:

•    Contraction
•    Recovery
•    Expansion
•    Slow-down

The nature of the relationship between assets classes changes across regimes, increasing or decreasing diversification benefits, which directly impacts the risk and return levels of any investment portfolio.  It is therefore in the interest of all savvy investors to become more regime-cognisant, especially during times of economic instability.

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