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Jun 30

Credit Informed Tactical Asset Allocation

Posted by abiao at 09:22 | Paper Review | Comments(0) | Reads(6869)
Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a portfolio’s asset allocation in order to improve the risk-adjusted returns of passive management investing. We know the performance of debt assets and equity are correlated somehow, this debt-equity relationship can be exploited profitably at the level of both individual companies and the market as a whole, for instance, if a company’s credit is going to outperform its equity, then a trade can be constructed to buy debt and sell (short) stock.

In the paper Credit Informed Tactical Asset Allocation by David Klein, he outlines a tactical asset allocation strategy that takes signals from the credit markets and applies them to the stock market. The strategy rules are straightforward:
1. If stocks appear undervalued relative to corporate bonds, go long stocks.
2. If stocks appear overvalued relative to corporate bonds, exit stock positions and buy short-term Treasuries.
the back-test of the strategy captures 65% of upside equity moves on a monthly basis while only taking 21% of the downside.

A comparison of this strategy with buy-and-hold is summarized
TAA performance
TAA performance graph

For detail please refer to the paper Credit Informed Tactical Asset Allocation downloadable at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1872163.

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