06/15/22 Tactical Asset Allocation 1 Tactical Asset Allocation Tactical Asset Allocation session session 5 5 Andrei Simonov
Jan 11, 2016
04/21/23Tactical Asset Allocation1
Tactical Asset Allocation Tactical Asset Allocation sessionsession 5 5
Andrei Simonov
04/21/23Tactical Asset Allocation2
AgendaAgenda
What is tactical asset allocation? Mean-variance perspective on TAA and SAA Predictability
– January dummy
– Business cycle variables
– Explaining risk premia: US, World, Sweden.
– Currency risk premia
– Caveats: data snooping, statistical issues.
04/21/23Tactical Asset Allocation3
What is TAA?What is TAA? Exists since early-to-mid- 80-ies. By now $100-200 bln are under management by TAA
managers A TAA managers’s investment objective is to obtain
better-than-expected return with (possibly) lower-than-benchmark volatility by forecasting the returns of two or more asset classes and varying asset class exposure in systematic manner (Phillips, Rogers & Capaldi, 1996)
Can TAA funds be interpreted as stand-alone asset class?
04/21/23Tactical Asset Allocation4
Conditioning Information and Portfolio Conditioning Information and Portfolio AnalysisAnalysis
Er
Vol
Add conditioninginformation and weightschange through time. Frontier shifts.
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Optimal portfolio for risk-averse investorOptimal portfolio for risk-averse investor
1V1
RV11R
V
1V1
1Vw
1V11V1
RV1
1RVw
1w
1VwR
1wVwwRw
V1w
1wVwwRw
1
11
portfoliomin var
1
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11
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21
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)(
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wwHere
E
04/21/23Tactical Asset Allocation6
Equilibrium and TAAEquilibrium and TAALet us assume that there exists long-term
expected returns vector e. However, due to predictability of asset returns, eE(R)
0)(
0)(
)(0
11
11
11
1
11
1
11
portfoliomin var
1
1*
nn
jj
nnTT
tTacticalBe
T
TT
etStrategicB
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TT
Global
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04/21/23Tactical Asset Allocation7
How to do it?How to do it?
We need a model that explains the connection between today’s variables and tomorrow returns.
Candidates: economic business cycle variables and Jan. Effect.
04/21/23Tactical Asset Allocation8
Example: Incredible January EffectExample: Incredible January Effect
Excess returns associated with small firms w.r.t. Large-cap stocks
Ritter: Tax effect. Is it so?Incredibly Shrinking January Effect
(William J. Bernstein ).
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Example: dividend yieldExample: dividend yield
Fama-French (1988). 1927-1986 Holding period
Coeff. t(coeff) R2
M 0.21 1.40 0.00 Q 1.07 2.10 0.01
1 2.47 1.27 0.01 2 7.38 2.04 0.09 3 9.94 2.21 0.13 4 12.86 2.43 0.19
• May not be sustained out of sample
04/21/23Tactical Asset Allocation10
Risk and return over the business cycleRisk and return over the business cycle mtmtmttm RrRE var, ? ? ? ?
G - 7 o u t p u t , 1 9 7 3 Q 2 t o 1 9 9 6 Q 2 o u t p u t l e v e l
p o t e n t i a l l i n e
e n d . r e c e s s b e g . e x p a n e n d . e x p a n b e g . r e c e s s A v e r a g e r e t u r n s
1 5 . 2 3 % 1 0 . 3 6 % 6 . 9 6 % 2 . 8 6 %
R e t u r n v o l a t i l i t y
1 2 . 5 9 % 1 0 . 6 3 % 1 6 . 8 5 % 2 6 . 9 8 %
US Term Structure 1970-1995US Term Structure 1970-1995
Andrei Simonov - debt and money markets11
04/21/23Andrei Simonov - debt and money markets12
Evaluation of 2001 and 2008 Evaluation of 2001 and 2008 RecessionsRecessions
In July 2000, the Yield Curve inverted forecasting recession to begin in June 2001.
Official NBER Peak is March 2001 (Yield Curve within one quarter accurate).
In March 2001, the Yield Curve returned to normal forecasting the end of the recession in November 2001.
On July 17, 2003 the NBER announced the official end of the recession was November 2001.
In August 2006 , the Yield Curve inverted forecasting recession to begin in July 2007.
Official NBER Peak is December 2007 (Yield Curve within two quarters accurate).
In May 2007, the Yield Curve returned to normal forecasting the end of the recession in January 2008.
On September 20, 2010 the NBER announced the official end of the recession was June 2009.
Recent recessions in retrospectRecent recessions in retrospectBusiness cycle Yield curve
NBER Peak
NBER Trough
Legth of Cycle
Inversion Lead Normal Lead Length of Inversion
Dec-69 Nov 70 11 Oct-68 14 Feb-70 9 16
Nov-73 Mar-75 16 Jun-73 5 Jan-75 2 19
Jan-80 Jul-80 6 Nov-78 14 May-80 2 18
Jul-81 Nov-82 16 Oct-80 9 Oct-81 13 12
Jul-90 Mar-91 8 May-89 14 Feb-90 13 9
Averages 11 11 7 15
Mar-01 Nov-01 8 Jul-00 8 Mar-01 8 8
Dec-07 June-09 18 Aug-06 16 May-07 12 9
Andrei Simonov - debt and money markets13
04/21/23Tactical Asset Allocation14
Yield Curve Inverts Before Last Six RecessionsYield Curve Inverts Before Last Six Recessions(5-year Treasury note minus 3-month Treasury bill yield-secondary)(5-year Treasury note minus 3-month Treasury bill yield-secondary)
-6
-4
-2
0
2
4
6
8
% Real annual GDP growth
Yield curve
RecessionCorrect 2 Recessions
Correct
RecessionCorrect
Yield curve accuratein recent recession
RecessionCorrect
Annual GDP growthor Yield Curve %
Data though April 11, 2006
Source: Campbell R. Harvey.
Recent flattening
04/21/23Tactical Asset Allocation15
Yield Curve Inverts Before Last Six RecessionsYield Curve Inverts Before Last Six Recessions(5-year Treasury note minus 3-month Treasury bill yield – constant maturity)(5-year Treasury note minus 3-month Treasury bill yield – constant maturity)
-6
-4
-2
0
2
4
6
8
% Real annual GDP growth
Yield curve
RecessionCorrect 2 Recessions
Correct
RecessionCorrect
Yield curve accuratein recent recession
RecessionCorrect
Annual GDP growthor Yield Curve %
Data though April 11, 2006
Source: Campbell R. Harvey.
Recent flattening
04/21/23Tactical Asset Allocation16
Recent Annualized One-Quarter GDP Growth Recent Annualized One-Quarter GDP Growth (10-year and 5-year Yield Curves-secondary market)(10-year and 5-year Yield Curves-secondary market)
-4
-2
0
2
4
6
8
-2
-1
0
1
2
3
4% Real annualized one-quarter GDP growth
Annualized 1-quarter GDP growth
Both curvesinvert 2000Q3
10-year
5-year
Yield curve
Data though April 11, 2006
04/21/23Tactical Asset Allocation17
Recent Annualized One-Quarter GDP Growth Recent Annualized One-Quarter GDP Growth (10-year and 5-year Yield Curves-constant maturity)(10-year and 5-year Yield Curves-constant maturity)
-4
-2
0
2
4
6
8
-2
-1
0
1
2
3
4% Real annualized one-quarter GDP growth
Annualized 1-quarter GDP growth
Both curvesinvert 2000Q3
10-year
5-year
Yield curve
Data though April 2006
04/21/23Tactical Asset Allocation18
Current yield curve(May 23rd, 12)Current yield curve(May 23rd, 12)
04/21/23Tactical Asset Allocation19
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1/4 1/16 1/28 2/9 2/21 3/5 3/17 3/29 4/10 4/22 5/4
June 2011 Meeting OutcomesImplied probability
0.0% - 0.25%
0.50%
0.75%
Producer Price index (Apr); Retail Sales (Apr); Business Inventories (Mar); Bernanke Speech
June 2012 meeting outcome
21
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
3/1 3/8 3/15 3/22 3/29 4/5 4/12 4/19 4/26 5/3 5/10
August 2011 Meeting OutcomesImplied probability
0.0% - 0.25%
0.50%
0.75%
Producer Price index (Apr); Retail Sales (Apr); Business Inventories (Mar); Bernanke Speech
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
4/1 4/6 4/11 4/16 4/21 4/26 5/1 5/6 5/11
September 2011 Meeting OutcomesImplied
probability
0.0% - 0.25%
0.50%
0.75%
Producer Price index (Apr); Retail Sales (Apr); Business Inventories (Mar); Bernanke Speech
Duke survey: Duke survey: optimism is up. optimism is up. Pessimistic Pessimistic /Optimistic /Optimistic CFOsCFOs
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04/21/23Tactical Asset Allocation25
Annual Real Economic Growth After Annual Real Economic Growth After Yield Curve InversionsYield Curve Inversions
0.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%4.00%4.50%
Up to one year afterinversions
Other quarters
04/21/23Tactical Asset Allocation26
Stock Returns and U.S. Yield CurveStock Returns and U.S. Yield Curve
-0.5
0
0.5
1
1.5
2
2.5
3
AU AT BECA DK FR DE
HK IT JP NLNO SG ES SE CH
UK USW
O
Inversion Normal
Average Monthly Returns in %
Data throughNovember 2000
04/21/23Tactical Asset Allocation27
Average Monthly Stock Returns After Average Monthly Stock Returns After Yield Curve InversionsYield Curve Inversions
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
After first month ofinversion
Normal
Equally weighted
Value weighted
Based on 19 countries.
Trader’s calendar Trader’s calendar (from thestreet.com)(from thestreet.com)
04/21/23Tactical Asset Allocation28
Time (EST)
Indicator (click for definition)
Source (click for press release)
Actual ForecastPrevious (revised)
Previous (original)
Monday, May 21No releases.
Tuesday, May 229 a.m. ICSC-UBS Weekly Chain Store Sales Snapshot for
the week ended May 19 International Council of Shopping Centers and UBS
-1.5% n.a. +0.8% +0.8%
9 a.m. Johnson Redbook Retail Sales Index for the week ended May 19, vs. April
Redbook Research +2.0% n.a. +2.2% +2.5%*
Wednesday, May 239 a.m. Mortgage Applications Survey for the week ended
May 18 -- Market Composite Index Mortgage Bankers Association-- n.a. -- 675.5
Purchase Index -- n.a. -- 432.39 a.m. Consumer Comfort Index for the week ended May
20 ABC News and Washington Post -- n.a. -- -7
Thursday, May 248:30 a.m. Initial Jobless Claims for the week ended May 19
Labor Department-- +305,000 -- +293,000
Four-week average -- n.a. -- +306,0008:30 a.m.
Durable goods orders for April Census Bureau
-- +0.9% -- +3.7%
Ex-transportation -- n.a. -- +1.5%
10 a.m. New home sales for April Census Bureau -- .860M -- .858M
2:30 p.m.
Treasury auction announcementBureau of the Public Debt
The Treasury announces the size of its next monthly two-year note auction, next Tuesday.
Friday, May 25 10 a.m. Existing Home Sales for April National Association of Realtors -- 6.10M -- 6.12M
10:30 a.m. Weekly Leading Index for the week ended May 18 Economic Cycle Research Institute -- n.a. -- +6.1%
04/21/23Tactical Asset Allocation29
What variables matter?What variables matter?
Methodology: 1. Exploratory: regressing
returns at t on informational variables at t-1
2. ”Correct one”: first finding economic risk premia (a la APT) and then regressing it on informational variables at t-1
04/21/23Tactical Asset Allocation30
Do informational variables have Do informational variables have predictive ability?predictive ability? Info variables:
– January dummy
– Past excess return on Equally weighted CRSP index
– Spread between 1 and 3 mo T-bills
– Dividend yield
– Spread between Baa and Aaa corporate bonds
– 1-mo T-bill rate
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Here how it looks like...
04/21/23Tactical Asset Allocation32
Performance & Business CyclePerformance & Business Cycle
-30
-20
-10
0
10
20
30
Expansion geometric mean Recession geometric mean
Average Annual Returns During U.S. Business Cycle Phases
Data through June 2002
04/21/23Tactical Asset Allocation33
Performance & Business Cycle (2)Performance & Business Cycle (2)
0
10
20
30
40
50
60
Australi
a
Austria
Belg
ium
Canad
a
Den
mar
k
Finlan
d
France
Ger
man
y
Hong K
ong
Irelan
d It
aly
Japan
Nether
lands
New
Zea
land
Norway
Portugal
Spain
Swed
en
Switzer
land
UK USW
orld
World
ex-U
S
EAFE
Expansion std.dev. Recession std.dev.
Average Annual Volatility During U.S. Business Cycle Phases
Data through June 2002
04/21/23Tactical Asset Allocation34
Performance & Business Cycle (3)Performance & Business Cycle (3)
-0.2
0
0.2
0.4
0.6
0.8
1
Australi
a
Austria
Belg
ium
Canad
a
Den
mar
k
Finlan
d
France
Ger
man
y
Hong K
ong
Irelan
d It
aly
Japan
Nether
lands
New
Zea
land
Norway
Portugal
Spain
Swed
en
Switzer
land
UK USW
orld
World
ex-U
S
EAFE
Expansion correlation with US Recession correlation with US
Correlations During U.S. Business Cycle Phases
Data through June 2002
04/21/23Tactical Asset Allocation35
3. Performance & Business Cycle (4)3. Performance & Business Cycle (4)
0
5
10
15
20
25
30
35
40
45
Australi
a
Austria
Belg
ium
Canad
a
Den
mar
k
Finlan
d
France
Ger
man
y
Hong K
ong
Irelan
d It
aly
Japan
Nether
lands
New
Zea
land
Norway
Portugal
Spain
Swed
en
Switzer
land
UK US
World
World
ex-U
S
EAFE
Expansion covariance with US Recession covariance with US
Covariances During U.S. Business Cycle Phases
Data through June 2002
04/21/23Tactical Asset Allocation36
How important are global factors?How important are global factors? Based on Ferson-Harvey RFS95 Question here is: what is more important, local or global
factors for predictability of asset returns. Global Informational variables: : ”old friends”: 1 mo t-bill, div.
Yield on MSCI World index, spread between 10yr and 3 mo T-bills, Eurodollar/US treasury spread, lagged market return, January dummy.
Local informational variables: Country x div. Yield, 30-day t-bill rate, term spread, lagged MSCI country x market return.
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1,10
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04/21/23Tactical Asset Allocation37
So, what So, what matters?matters?
”Global only” model is already good enough
Adding local factors increases explanatory power of the model
04/21/23Tactical Asset Allocation38
Changes in Changes in vs changes in risk premium vs changes in risk premium
Only 2-4% of variation is due to beta’s.
)()'(
)()'('
EZEVarE
EZEVarEZEVar
04/21/23Tactical Asset Allocation39
What about currency risk premium?What about currency risk premium?
Currency specificiy: zero-sum gameDumas-Solnik: currency risk premia
exists. It is time-varying and predictable
04/21/23Tactical Asset Allocation40
Caveats:Caveats:
Data snooping– Foster, Smith and Whaley (98): by choosing to
max R2 via choice of instruments one can get significance when there is none.
– Not clear how to use as list of instruments already exists...
In-sample vs. Out-of-sample validation
04/21/23Tactical Asset Allocation41
Caveats(2)Caveats(2)
Statistical biases: autocorrelation, heteroscedastisity (via Monte-Carlo simulations).
Non-normality, excess skewness and kurtosis
04/21/23Tactical Asset Allocation42
How to deal with statistical issues?How to deal with statistical issues?
Bootstrap methodology:– Form empirical distribution of returns – Generate time series of returns (length T).– Perform the regression of interest– See how many times there exists significance
on level .
04/21/23Tactical Asset Allocation43
U.S. Risk PremiumU.S. Risk Premium
Survey BackgroundSurvey Background
Graham/Harvey: Survey CFOs every quarter Q2 2000 through Q4 2008 (52 quarters) Current survey attracts about 500 respondents
Why CFOs? – We know from previous surveys and interviews that the
CFOs use the risk premium for their capital budgeting
– Hence, they have thought hard about risk premium
– Should not be biased the way that analyst forecasts might be
04/21/23Tactical Asset Allocation44
U.S. Risk PremiumU.S. Risk Premium
Ten-Year PremiumTen-Year Premium
04/21/23Tactical Asset Allocation45
04/21/23Tactical Asset Allocation46
Duke CFO magazine Global Business Outlook survey - U.S. - First Quarter, 201014. On February 12, 2010 the annual yield on 10-yr treasury bonds was 3.7%. Please complete the following:
Mean SD 95% CIMedianMinimumMaximum TotalOver the next 10 years, I expect the average annual S&P500 return will be: There is a 1-in-10 chance it will beless than: 1.30 8.13 0.61 - 1.99 2 -50 75 535Over the next 10 years, I expect the average annual S&P500 return will be: Expected return: 7.62 9.66 6.81 - 8.43 6 -20 100 544Over the next 10 years, I expect the average annual S&P500 return will be: There is a 1-in-10 chance it will begreater than: 11.76 11.43 0.79 - 12.72 10 -10 100 537Over the next year, I expect the average annual S&P 500return will be: There is a 1-in-10 chance it will be lessthan: -3.31 11.64 -4.30 - -2.33 0 -50 75 535Over the next year, I expect the average annual S&P 500return will be: Expected return: 5.62 8.44 4.91 - 6.33 5 -25 100 544Over the next year, I expect the average annual S&P 500return will be: There is a 1-in-10 chance it will begreater than: 11.39 8.81 10.65 - 12.14 10 -10 95 534
04/21/23Tactical Asset Allocation47
U.S. Risk PremiumU.S. Risk Premium
Momentum in Expectations for 1-year Momentum in Expectations for 1-year PremiumPremium
04/21/23Tactical Asset Allocation48
U.S. Risk PremiumU.S. Risk Premium
Extreme Returns Cause DisagreementExtreme Returns Cause DisagreementA. Disagreement over the one-year premium and past returns
y = -0.0614x + 3.9079R2 = 0.1684
y = 0.0194x2 + 0.0247x + 3.3696
R2 = 0.5892
0
1
2
3
4
5
6
-15 -10 -5 0 5 10
Past one-month excess S&P 500 return
Dis
agre
emen
t ove
r th
e on
e-ye
ar p
rem
ium
04/21/23Tactical Asset Allocation49
U.S. Risk PremiumU.S. Risk Premium
Positive Relation Between Disagreement Positive Relation Between Disagreement and Expected 10-year Returnsand Expected 10-year Returns
B. Ten-year premium and disagreement
y = 0.9777x + 1.5936R2 = 0.3165
0
1
2
3
4
5
6
7
8
1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9
Disagreement of ten-year premium forecasts
Mea
n te
n-ye
ar p
rem
ium
04/21/23Tactical Asset Allocation50
Conclusion:Conclusion:
TAA can be an important tool in asset allocation methodology.
It is based on time variation of real economic risk premia.
Selection of predictors is important.We are still in ”top-down” paradigm.Devil is in the details= implementation
matters.