State Street Associates

History, Shocks and Drifts: A New Approach to Portfolio Formation

Manage what matters, whether it happens fast or slow

April 2021

Portfolios face many risks. Some may be gradual but persistent, like climate change and demographic shifts; while others happen suddenly, like pandemics or financial crises.

To manage the possibilities, investors must unify their view of major events that might happen over long intervals with those that might happen along the way. The future will surely bring both, with echoes of history and a healthy dose of new trends. We propose a method of portfolio construction that accounts for complexities while recognizing that most investors care about performance measured over many frequencies — monthly, yearly, five-year, for example — not just one or the other. We show how to create a sample of mixed-frequency scenarios that is balanced and consistent. And we show how to form portfolios that consider all of the returns of this sample, rather than a statistical summary of them.