Strategic asset allocation sets the investment targets, ranges, operational constraints and investment restrictions that are part of a company's investment policy statement. Tactical asset allocation (TAA), on the other hand, allows for shifts in the strategic asset allocation targets, subject to the strategic ranges, based on short- to intermediate-term economic and market outlooks. The goal of TAA is to outperform the results that would be achieved from strict adherence to the SAA. Security selection refers to the buying and selling of specific securities. Whereas tactical asset allocation attempts to add value by correctly adding to or reducing the amounts placed into individual asset classes, security selection attempts to add value by outperforming the benchmark indexes used to proxy the individual asset classes.
In this paper we deal with only the strategic asset allocation component of the investment process, as DFA is not an appropriate tool for performing tactical asset allocation or security selection. While many strategic questions could be addressed, given the limitations of information about DFAIC, we will concentrate on the following three major strategic investment issues:
the target fixed-income duration;
the target allocation to equities; and
The target split between taxable and tax-exempt bonds.
To address these issues we will make use of the optimization algorithm within the FIRM system to identify DFAIC's efficient frontier~. The objective function will be the one discussed in step 1 of the DFA process. Our first efficient frontier will be subject to the continuation of the current reinsurance program. Exhibit 5 shows DFAIC's economic value efficient frontier at the end of five years along with the position of their current asset allocation strategy.