Abstract
Buy and hold strategies make staying disciplined difficult for investors, especially given the variability of returns for different asset classes/strategies during divergent market conditions. Market timing strategies, on the other hand, present significant theoretical benefits, but in reality these benefits are difficult to obtain. Tactical asset allocation, where limited deviations from the strategic allocation are allowed permits the portfolio manager to take advantage of market conditions fits between these two extremes. The authors correlate daily returns for each of eighteen separate asset classes typically used in diversified institutional portfolios and daily closing values of the VIX (the ticker symbol for the Chicago Board Options Exchange Volatility Index). This information is used to select those classes whose returns are most responsive to the level of the VIX. Portfolio allocations for eight selected asset classes are revised depending on the level of the VIX at the daily close of the market. The portfolio is rebalanced on the business day following the day the VIX hits the trigger value. The VIX tactical allocation overlay yields an increase in return over the buy and hold portfolio of approximately 38 basis points. The authors conclude that the tactical asset allocation strategy based on the level of VIX provides a higher return than the neutral buy and hold allocation with a higher Sharpe ratio and lower volatility.
Highlights
One of the closely held tenets of the investing is to determine long-term goals, to choose an asset allocation strategy, which enables the portfolio to meet those goals, and, to revisit and revise the allocation periodically, if necessary
The authors correlate daily returns for each of eighteen separate asset classes typically used in diversified institutional portfolios and daily closing values of the VIX
This paper develops a tactical overlay strategy based on the value of the VIX index
Summary
Market timing and its potential profits have been an allure for investors since the dawn of investing. French et al (1987) showed that the risk premium for equities was positively correlated with the predicted level of volatility, which, in turn, produced a strong negative correlation with unexpected changes in market volatility and excess returns. Munenzon (2010) demonstrated that correlations among alternative investment strategies are unstable, producing outsized benefits in times of heightened market risk. Many of the assets and strategies that are desired during periods heightened market volatility are the assets investors should minimize to enhance returns when markets are good. A tactical strategy that reduces portfolio risk during more volatile times should allow investors to experience less anxiety and be more likely to remain strategically invested
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