GLOBAL - The financial crisis has forced investors to take a more nuanced approach to portfolio risk management, according to State Street.

In its latest Vision Focus report on asset-allocation trends, State Street said the extreme market volatility of 2007-09 made many investors question a number of "long-held tenets" of asset allocation".

Dan Farley, global head of Multi-Asset Class Solutions at State Street Global Advisors, said the crisis exposed the need to "understand the limitations of traditional practices", such as Modern Portfolio Theory, and "heightened the need for new approaches" to strategic and tactical asset allocation.

"Thanks to lessons learned from this period," he added, "many investors have gained a more nuanced reminder of portfolio risks centring on market volatility, portfolio construction and trading liquidity."

The report, entitled Rethinking Asset Allocation, found investors have moved increasingly away from risk models centred on average market behaviour and normal return distributions, instead adopting strategies that focus market turbulence, risk, liquidity and diversification. 

The report also said investors would do well to consider "within-horizon" risk, investment regimes and turbulence, in light of the strong possibility that "non-normal" investment returns and "dramatic swings in valuation" might occur more frequently in the coming years.
Will Kinlaw, managing director of Portfolio and Risk Management Research at State Street Global Markets, said investors were turning more and more to "regime-specific" risk analysis to get a clearer picture of portfolio risk.

He said: "The study of turbulence, a statistical measure designed to identify periods of unusual financial returns, helps us to understand how specific market segments react during turbulent and non-turbulent times."

The study of turbulence and unusual price movements, he added, can help investors to better understand market sentiment and build more robust risk models.