A static or an adaptive portfolio? The fatal attraction of a beautiful theory

November 2016
Behavioural_paper game_small
It shouldn’t come as a surprise that a static asset allocation in an uncertain world would lead to unstable outcomes. But if we want or need more predictable results maybe it’s time to adapt our approach.

An adaptive approach to asset allocation could lead to more stable results, but it requires revisiting some traditional views, more work and additional governance.

Many pension schemes have suffered unstable outcomes – volatile funding levels and ballooning deficits. With static asset allocations in an uncertain and complex world maybe this is to be expected.

Why then do so many schemes hold static portfolios? Often the static asset allocation is set using statistical asset-liability models. These models are typically based on long-term assumptions that humans all act rationally and that booms and busts cannot happen.

If you want, or need, more predictable solvency results in this uncertain world, maybe it’s time to adapt to a reality that recognises man is irrational and that booms and busts do occur.

A portfolio that is robust to a range of economic conditions and resilient to market stresses will deliver more predictable results. This needs a different approach to portfolio construction; a scenario approach that adapts over time to reflect the current market conditions and the outlook ahead.

The full paper is available here.