Strategic Asset Allocation

Abstract

To implement strategic asset allocation, we must determine risk and return expectations for the various asset classes. Starting from the paradigm that long-run asset returns are determined by the long-run fundamentals of the economy, a fair value approach to building expectations is crucial. This paper proposes to formalize a quantitative and systematic methodology for optimizing portfolios, from the determination of long-run fundamental pillars, through the modeling of asset returns and the assessment of market risks. We apply forecasting models and build in the specific of the main asset classes, (equities, bonds and alternative investments), depending on the uncertainties they represent for the risk-averse investor. Our resulting allocations, within the equity asset class and with regard to the place of alternative investments, question the choices of long-term institutional investors, such as pension funds that have shifted their long-run allocations in response to the recent financial crisis.

Keywords: long-term investment policy, strategic asset allocation, tactical asset allocation, risk premium, long-run economic growth, Solow model, Phillips curve

JEL Classification: E20, E50, G11