Strategic Risk Management

CHAPTER 7Out-of-Sample Evidence from the COVID-19 Equity Selloff

INTRODUCTION

We have advocated a quantitative approach to strategic risk management that involves the addition of positive convexity strategies, as well as three portfolio management tools: strategic rebalancing, volatility targeting, and drawdown control. Much of this research was conducted in the late 2010s, when equity and bond markets were booming and the U.S. economy was in a historically long period of uninterrupted growth. Volatility was low and confidence high.¹

We believed the time was right to undertake a research program on the topic of strategic risk management, which involves the integration of risk management and the investment function. Given that many markets were at all-time highs, it seemed prudent to develop investment programs that sought crisis alpha (i.e., outperformance during the inevitable drawdown).

But was the success of our methods due to the particular sample period that we examined? The best way to test is with an out-of-sample exercise. The COVID-19 pandemic produced an equity drawdown that offered an ideal test of our defensive strategies and portfolio management tools.

Chapters 1 through 6 of this book were written over the 2016–2019 period and focus on the topic of strategic risk management, which is the embedding of risk management into investment strategy design. In Chapters 1 and 2, we studied time-series momentum (or trend-following) strategies and noted that faster formulations ...