Index Performance in Changing Economic Environments

categories: Indexes, Asset Allocation and Asset Liability Management, Investing (Investment Management), Portfolio Construction and Optimization, Risk Management, Factor Indexes, Equities, Minimum Volatility Indexes, MSCI Size Indexes, MSCI Sector Indexes, Asset Pricing and Valuation, Research Paper, SURYANARAYANAN Raghu, VARGA Katalin, GUPTA Abhishek, KASSAM Altaf

Over the recent years, the impact of the macroeconomic regime on their investments has grown in importance for institutional investors. As a result, institutional investors have started explicitly accounting for macroeconomic conditions in their asset allocation decisions.

This paper attempts to provide a framework for designing macro-sensitive portfolios, building on historical analysis using our 40+ years' history of MSCI Factor and Sector Indexes, and a long-term analysis based on the forecasts from MSCI Macroeconomic and Asset Pricing Models. We identify historical and statistically plausible economic growth and inflation regimes, and their transitions, and show how factor and sector indexes differ in their response to changes in these regimes. Deviations away from the market and towards factor and sector indexes could depend both on institutional investors' macroeconomic views and tolerance for macroeconomic uncertainty. For an uncertainty tolerant investor assuming DM economic growth returns quickly to its trend, the models indicate allocating towards indexes that are the most sensitive to economic growth. In contrast, if slow growth and low inflation are believed to persist, the models indicate allocating towards the least growth sensitive indexes.

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