Tactical Asset Allocation, Risk Premia, and the Business Cycle: A Macro Regime Approach

Abstract

Market conditions change over the course of the business cycle. When are investors compensated to take risk? And what type of risk? This article proposes a practical regime-based framework for tactical asset allocation (TAA), combining leading economic indicators and global risk appetite to identify four macro regimes: recovery, expansion, slowdown, and contraction. The authors document distinct performance characteristics across regimes for traditional asset classes and their underlying risk factors, focusing on the term premium, credit premium, and equity premium. They provide simple and practical examples of TAA strategies for long-only multi-asset and fixed-income portfolios with the potential to generate attractive excess returns. Results are statistically significant and economically relevant after transaction costs, with information ratios between 0.70 and 0.80.