Adaptive Asset Allocation Policies

Many institutional and individual investors have an asset allocation policy that calls for investing a specified percentage of the total value of a portfolio in each of several asset classes. To conform with such a policy as market values change requires selling assets that performed relatively well and buying those that performed relatively poorly. Such a strategy is clearly contrarian and can only be followed by a minority of investors. In practice, many investors seldom rebalance completely to conform with their policy. On the other hand, many multi-asset mutual funds, increasingly used in defined contribution plans, do so frequently, resulting in contrarian behavior. This paper presents an alternative approach, in which an asset allocation policy adapts as markets move, taking into account changes in the outstanding market values of major asset classes. Such policies can take important information into account, reduce or avoid contrarian behavior and could be followed by a majority of investors.