Dynamic asset allocation strategy: an economic regime approach

Abstract

This paper presents a practical investment framework for dynamic asset allocation strategies based on changes in the macro-environment. To identify economic regimes, we use macro-indicators that track monthly growth and inflation of the US economy. We then demonstrate that the regimes divided by changes in growth and inflation trends successfully partition the historical performance of asset classes, and construct a regime-based dynamic strategy for shifting exposures toward attractive assets according to economic regimes. Out-of-sample analysis suggests that the dynamic approach outperforms the static approach after accounting for transaction costs, leading to a higher risk-adjusted return and information ratio. These results have crucial implications for portfolio managers seeking to develop a dynamic asset allocation strategy throughout economic cycles to enhance long-term portfolio performance. © 2022, The Author(s), under exclusive licence to Springer Nature Limited.