Total Return Strategies for Multi-Asset Portfolios: Dynamically Managing Portfolio Risk
Posted: 25 Oct 2007
Abstract
Traditional balanced funds with a more or less constant stock allocation cannot solve the conflict of various investment horizons that most institutional investors face. In order to generate capital gains, large allocations in risky asset classes such as equities are needed. However, this is not reconcilable with short-term requirements such as avoiding losses on an annual basis. In this article, we investigate a risk-based total return strategy that explicitly controls for shortfall risk and that, at the same time, utilizes the available risk budget in an effective way to enhance the performance potential in the long-run. As it allows for larger shifts in asset class weights over time, it can start with larger allocations to stocks or other risky asset classes compared to static strategies. We compare this risk-based strategy to several dynamic asset allocation approaches in a backtest and also provide an extensive simulation study to quantify short-run hedging effectiveness and long-run hedging costs.
Keywords: shortfall risk, total return strategies, portfolio insurance, rainbow options
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