For long-term investors it is common to design a long-term investment strategy, which aims to generate return to reach their objectives (e.g. long-term benefit payments). However, every investor knows that a lot can happen between now and the long term.
A good example is the current low yield environment, the potential reversion to higher interest rates and the impact this may have on equity returns. The definition of a strategic risk budget enables to act on such market circumstances, in a controlled way without violating the long-term investment strategy. It facilitates Dynamic Asset Allocation (DAA) for top-down risk on/ risk off decisions in addition to the long-term strategy. The main question that of course arises is which signal to incorporate when making these risk on / risk off decisions.
Research shows that the OFS risk and return projections are beneficial in this DAA process. First of all to support the DAA decision to generate additional return. Second, to evaluate whether the DAA is compliant with the strategic risk budget, based on a consistent methodology.
This article presents the results of a back-test (1999-2017), which shows clear added value of OFS for annual DAA decisions to generate excess return compared to a simple static Strategic Asset Allocation (SAA).