Elastic Asset Allocation — Legacy Defensive (EAA-LEG-DEF)
Developed by Keller & Keuning · Breadth Momentum · Med Risk
The Legacy Defensive variant of Elastic Asset Allocation applies the more conservative elasticity formula to the same twelve-asset universe and PAA breadth protection mechanism used by its offensive counterpart. Published alongside the offensive variant in Keller and Keuning's research (SSRN #2759734), EAA-LEG-DEF uses a dampened scoring function — z = r / (1 + c) — that reduces the spread between high and low-scoring assets compared to the offensive formula, producing more diversified portfolios with lower concentration risk and smoother returns.
The defensive formula divides the return by one plus the correlation, rather than multiplying by one minus the correlation as in the offensive variant. This mathematical difference has a significant practical impact: the offensive formula can produce very large score differentials when an asset has both high return and low correlation (approaching the full return value), while the defensive formula compresses scores into a narrower range (the maximum achievable score is the return divided by one, which occurs only at zero correlation). This compression produces more balanced allocation weights and reduces the portfolio's dependence on any single position's accuracy.
The philosophical distinction mirrors that between the standard EAA offensive and defensive variants: the legacy defensive prioritizes consistency and capital preservation over maximum return capture. By dampening the scoring function, the strategy accepts lower returns during strong trending environments in exchange for reduced volatility and smaller drawdowns across all market conditions. The integrated PAA breadth mechanism provides the same graduated crash protection as the offensive variant, scaling the defensive allocation proportionally to the breadth of market weakness.
This combination of dampened scoring with graduated breadth protection creates one of the most conservative strategies in the Keller research family. The portfolio is rarely concentrated in a small number of positions (due to the compressed scoring) and frequently carries a meaningful defensive allocation (due to the breadth sensitivity). The result is a low-volatility, low-drawdown approach that sacrifices upside potential for consistency — a profile well-suited to risk-averse investors or as a stabilizing component within a broader multi-strategy portfolio.
How It Works
Dampened Elasticity Scoring
Each asset is scored monthly using the formula: z = r / (1 + c), where r is the trailing twelve-month return and c is the average pairwise correlation with other universe members. The division by (1 + c) compresses the score range relative to the offensive formula's multiplication by (1 - c). An asset with 15% return and 0.5 correlation scores 15% / 1.5 = 10% under the defensive formula, compared to 15% × 0.5 = 7.5% under the offensive formula — the scores converge toward the middle of the range rather than spreading toward the extremes.
This compression means the top-ranked and bottom-ranked assets have more similar scores, producing portfolio weights that are more evenly distributed among the selected positions. The practical effect is a portfolio that holds more balanced positions rather than concentrating heavily in the single strongest trend, reducing the impact of any individual ranking error on overall returns.
Breadth Protection and Defensive Allocation
The PAA breadth mechanism operates identically to the offensive variant — counting assets with positive momentum and converting the breadth score into a crash protection fraction. The same twelve-asset universe provides the breadth measurement, and the same sensitivity parameters control the speed of the defensive scaling. The defensive allocation is directed to short-term and intermediate Treasuries based on their relative strength.
The interaction between the dampened scoring and the breadth protection amplifies the strategy's conservative character. During periods of deteriorating breadth, two protective mechanisms are operating simultaneously: the breadth system is increasing the overall defensive allocation, while the dampened scoring is ensuring that whatever remains invested is distributed more evenly across qualifying assets rather than concentrated in a single perceived winner. This double conservatism produces noticeably lower volatility than the offensive variant.
Practical Risk Profile
The legacy defensive variant occupies the conservative end of the Keller strategy spectrum. Its combination of dampened scores, diversified weights, and graduated breadth protection produces a portfolio with equity-like expected returns over full market cycles but bond-like volatility and substantially reduced maximum drawdowns. The strategy rarely experiences large single-month losses because its inherent diversification prevents any single position from dominating the portfolio's risk exposure.
The trade-off for this consistency is visible during strong trending markets. When a single asset class is dramatically outperforming everything else — as US large caps did for much of the 2010s — the dampened scoring prevents the portfolio from concentrating sufficiently to capture the full upside. Investors comparing the defensive variant to the offensive variant during trending markets will see meaningfully lower returns. However, during volatile or declining markets, the defensive variant's lower drawdowns and faster recovery times can produce superior compound returns over complete market cycles.
Explore Elastic Asset Allocation — Legacy Defensive (EAA-LEG-DEF)
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