Dynamic strategic asset allocation: Risk and return across the business cycle

We propose a practical investment framework for dynamic asset allocation across different phases in the business cycle, which we illustrate using a sample of US data from 1948 to 2007. We identify four phases in the business cycle and find that these capture pronounced time variation in the risk and return properties of asset classes. Time variation is also observed in the risk of a traditional, static strategic asset mix. In order to stabilize risk across the business cycle, we propose a dynamic strategic asset allocation approach, which has the potential to enhance expected return as well. The proposed investment framework is found to be robust to variations in the variable composition of the business cycle indicator and can easily be extended with different economic variables and/or additional assets. © 2011 Macmillan Publishers Ltd.