For the past five decades, investors have increasingly relied on modern portfolio theory. Since its acceptance, diversification of assets, asset classes, and geographies was accepted as the optimal method to protect against market downturns. The determination of an optimal portfolio was built on a historical and relatively static view of long-term asset returns, risk measurements, and cross asset correlations.
In 2008, as panic hit the world’s investment markets, statically diversified portfolios suffered material losses. Investors witnessed a broad decline across almost all asset categories and geographies. It was the latest example of a static approach providing a false sense of security. Ultimately, the strategy failed to protect capital when protection was needed most.
Though basic research on regime detection was performed throughout the 1990’s and early 2000’s, it took the Great Financial Crisis to put regime-based investing into practice.
Regime based investing is based on the premise that the investment environment is not static and therefore, the allocation of asset categories shouldn’t be either. Research shows that different investment styles and factors have demonstrated varying levels of success at different times. It demonstrates that the value added to investing can change throughout time, highlighting the need to adapt the investment process to the environment.