Economic Regime Management: Part I

Abstract

Economic Regime Management (ERM) is a framework to help investors understand how economic conditions affect their overall portfolios and individual investments. While intuitively investors know that economic factors are intimately related to future returns, no clear method exists to incorporate that information into actionable knowledge. This remains the case despite the fact that the relationship between many of the factors we will discuss and asset returns have been widely studied through time. While insightful and innovative research on this topic is plentiful, the ERM methodology focuses on being truly implementable in real-world scenarios, in real-time. This focus on implementation and a few key principles will allow ERM to avoid some of the common pitfalls in the use of economic factors. While we do not endeavor to cover all of the process details completely in this paper, we will give an intuitive explanation for the usefulness of the ERM framework.

This paper will show how they can isolate individual sources of risk at a macro-level. Utilizing this information, investors can more easily find solutions that provide the best risk and return profiles while diversifying the sources of risk and return effectively. Finally, using insights about economic regimes, an investor can conduct scenario analyses that illustrate how different economic scenarios may affect investor’s portfolios.

Keywords: economic, regime, regimes, modeling, factors, investment, investments, performance, assets, expectations, surprise, uncertainty, sensitivity

JEL Classification: C50, G23