Combining Asset and Factor Allocation for Strategic and Tactical Portfolios
Summary
This article presents a multi-asset allocation framework that combines traditional asset selection with allocation to systematic factors. It maps macroeconomic variables and style factors to asset classes, estimates exposures with time-series regressions, and constructs investable factor-mimicking portfolios. Historical average returns are used to forecast factor returns, with different lookback horizons for tactical and strategic decisions. Optimized factor portfolios then imply expected asset returns, which feed a final constrained portfolio optimization. The framework also allows discretionary views to adjust for asset-specific effects that the systematic factors miss.
The worked example uses ten U.S.-oriented assets and selected growth, inflation, real-rate, momentum, and volatility factors. It reports positive excess returns for the simulated factor portfolios and, across three illustrative strategies, Sharpe ratios of 0.82–0.94, annual turnover of 23%, and tactical information ratios of 0.52–0.75. These results come from a historical demonstration and do not establish robustness beyond the sample. The article identifies reliable factor forecasts as a central challenge and notes that tactical factor portfolios were more volatile than strategic ones.
Key ideas
- The framework makes factor exposures an intermediate step between asset selection and portfolio construction.
- It combines macroeconomic and style factors, with exposures estimated through time-series regressions.
- Factor-mimicking portfolios are forecast using historical averages over horizons suited to strategic or tactical allocations.
- Discretionary views can adjust expected returns for asset-specific opportunities the systematic factors do not capture.
- The reported performance is illustrative and depends on the reliability of factor forecasts.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.