A balanced portfolio still offers the best equity returns have reduced the equity risk chance of success premium. This is reflected in the TVAA portfolio The policy response to higher and more persistent with a 10-percentage-point decrease in the inflation and the subsequent repricing of risk in equity allocation, which is a meaningful global capital markets has led to a dramatic derisking move. shift in our time-varying asset allocation (TVAA) This TVAA strategy breaks down the major asset outlook. The TVAA looks to harvest the risk class into smaller sub-assets to provide additional premia for which we think there is modest return portfolio tilt benefits. On the domestic equity predictability based on the VCMM. It leverages front, we see a tilt toward the value factor given the Vanguard Asset Allocation Model (VAAM) favorable risk and return characteristics. Within to optimize a portfolio that maximizes end-of- international equities, there is an equal allocation period wealth with a penalty for dispersion of to emerging markets and developed (ex-U.S.) outcomes based on our 10-year return forecasts markets given emerging markets’ lower (Aliaga-Díaz et al., 2022). Figure II-17 shows the correlation with U.S. equities. On the domestic optimal TVAA portfolio, based on our current fixed income side, the portfolio is tilted toward outlook, versus its policy benchmark, which credit given the time diversification benefits we is a 60% stock/40% bond portfolio. outlined earlier in this section and the higher TVAA methodology is appropriate for investors expected returns in Figures II-5a and II-9a. who are willing to take on active risk in the form In short, the TVAA portfolio is inclined toward of “model forecast risk.” For investors whose reducing equity risk because of the compressed objectives and risk tolerances make it prudent equity risk premium and reallocating it toward to consider adjusting their asset allocations when fixed income with a credit tilt. This results in market conditions materially change, the VAAM, a lower volatility for the TVAA portfolio while combined with time-varying VCMM asset returns, producing expected returns similar to those provides a consistent and holistic way to analyze of the 60/40 benchmark (Figure II-18). Although the trade-offs in time-varying portfolio solutions. the expected Sharpe ratio and maximum The TVAA portfolio targets the same risk profile drawdown of the time-varying portfolio are as the traditional benchmark portfolio, with the better than that of the benchmark 60/40 flexibility to deviate from the benchmark based portfolio, this comes at the expense of active on the Vanguard projected outlook. The global risk (that is, tracking error to the benchmark) interest rate tightening cycle in 2022 has raised of 2.3%, which translates to a 51% probability our expected bond return forecasts by more than of underperforming the benchmark in any the equity market sell-off has raised expected given year. equity returns. Higher bond returns and lower 56