Static vs. Dynamic Investment Policy: Matching Asset Management to Investor Risk Preferences

http://www.schultzcollins.com/files/staticvsdynamic.pdf


Many investment policies have guideline asset allocations that target a constant
proportional weighting between stocks and bonds during both bull and bear markets.  A
“Constant Mix” asset management approach is defensible under a variety of commonly
held assumptions.  Generally, a recommendation to “stay the course” during volatile
market conditions implicitly assumes that investors, will benefit from a Constant Mix
approach.  Investors, however, are not a homogeneous group; and, for some, changes in
wealth may cause changes in risk tolerance.  Wealth management, therefore, may require
dynamic changes in both asset allocation as well as other aspects of investment policy
such as rebalancing, distribution and monitoring & surveillance policies.  
This article outlines several asset management approaches and discusses the importance
of aligning Investment Policy with investor risk preferences.  If the investment policy
ignores this critical “calibration,” there is little hope that the investor will be able to
maintain the policy during recessionary periods.  It presents a follow on simulation study
to illustrate the range of possible portfolio evolutions under various asset management
approaches.  Finally, it focuses on how investment advisors can transition from static
(“blueprint” oriented) to dynamic (“systems engineering” oriented) investment policy by
using advanced simulation tools and by transforming set-in-stone asset management
guidelines into a sequence of periodic decisions regarding the exercise of asset
management options.