Research Review | 17 May 2024 | Market Analytics

The Capital Spectator

Regime-Based Strategic Asset Allocation
Eric Bouyé and Jerome Teiletche (World Bank)
April 2024
What should investors do in the presence of economic regimes? Researchers and practitioners usually address this topic from a tactical asset allocation point of view. In this article, we depart from the literature by tackling the issue strategically and analytically. Modeling economic regimes as a mixture of distributions, we first investigate what happens to moments of the distribution of returns. We next deduct the implications for portfolios built under popular asset allocation methodologies (mean-variance-optimization, risk budgeting). Using these analytical results, we define new portfolio construction methodologies seeking to exploit the information in macroeconomic (macro) regimes through the composition of optimal portfolios for each regime, the risk structure of these portfolios, and the long-term probability of the regimes. We empirically show that macro regime-based portfolios can outperform traditional asset-based portfolios, for both multi-asset and equity factor universes, over a sample of more than fifty years.

Do Oil Price Shocks Drive Risk Premia in Stock Markets? A Novel Investment Application
Riza Demirer (Southern Illinois University Edwardsville), et al.
March 2024
Motivated by the evidence from the investment-based theories in the asset pricing literature that links asset pricing factors to economic shocks, this paper examines the effect of disentangled oil price shocks on factor returns in a large set of 62 stock markets. Our findings show that oil market shocks capture significant predictive information regarding the size and direction of factor returns in global stock markets although we observe a great deal of heterogeneity in the response of factors to these shocks, depending on the market classification and the type of oil shock. We show that oil supply and precautionary demand shocks possess the greatest predictive power over systematic risk premia, particularly for value and momentum. We argue that time varying investor sentiment and the flexibility of firms to respond to economic shocks drive the responses of factors to oil market shocks. Further examining the economic implications of the predictive patterns observed, we show that a conditional global factor investing strategy wherein the investment positions are tilted towards factor-based portfolios conditional on the size and direction of the oil price shock yields significant improvements in portfolio returns and diversification over the passive investment strategy. Our findings show that the performance of smart beta strategies can be significantly improved by conditioning factor positions based on the size and direction of shocks.

Bond Risk Premiums at the Zero

The full article is available here. This article was published at The Capital Spectator.