The 2007-08 financial crisis upended some of the conventional wisdom about investing. Pension funds, insurance companies and other long-term investors were taught that the best way to mitigate risk was to diversify, stick to long-term allocations and rebalance automatically.

Risk was measured as tracking error against a benchmark, and absolute exposure was tallied as 'value at risk' (VaR), packaged in one nice, neat, single number.

The shock of the market dive in late 2008 and early 2009, however, saw virtually all asset classes bar US Treasuries correlate downward. For an extended period of time, rebalancing caused nothing but more pain. Long-term strategic allocations seemed suddenly fantastical. Tracking error became meaningless in the face of universal market crashes. And it turned out that the data inputs to VaR failed to give most investors anything resembling a true picture of their exposures.

This has led financial institutions and investors to seek new ways of conceptualising, measuring and mitigating risk, and some observers suggest they still have a fair amount to learn.

State Street Global Markets has come up with several tools it is now rolling out to clients meant to address these issues. It provides a bundled service of transition management/portfolio execution with asset-allocation advice.

Sebastien Page, Boston-based senior managing director of the portfolio and risk-management group, says a strategic asset allocation needs to be conditioned to meet current market conditions. "Risk management must be regime-specific," he says, because in periods of great turbulence, asset correlations break down, and this can do lasting damage to a long-term strategy.

Even if the long-term strategy is theoretically sound, it is impossible for many boards and investment officers to stomach the tail risks of massive market losses.

Of course, tactical asset allocation (TAA) has been around for decades, but Page says dynamic rebalancing is not the same thing. TAA is more flexible, and gives fund managers the discretion to seek alpha in short-term scenarios. Dynamic or optimised portfolio strategy maintains the long-term allocation, but allows investors to react if they face losses.

"Risk is not the same thing as volatility," Page says. "Risk is about exposure to losses. A strategic investor wants a risk-management process based on the likelihood of large losses, not just simple volatility."

This sounds smooth, but who is better off today -- the investor that blindly rebalanced, or the one that waited until some point in 2009 to return to equities and other risk assets, or perhaps the one that paid transaction costs on 'dynamic' structures?

Page says that, with time, the difference between those who blindly rebalanced versus those that tried to time their entry has narrowed. But either way, he says, the investors made a conscious decision that was akin to market timing - the kind of decision that a well-paid hedge-fund manager is used to making, but not pension fund CIOs.

As for the question about the cost of rebalancing dynamically -- as such services come with fees -- Page says this can be optimised via technology. The question of when and how to rebalance varies by frequency, timing and asset class. However, he says paying for a dynamic rebalancing strategy can save 20-40% against the same tracking error, over time.

Dynamic hedging is the sales term; in practice, this means using derivatives to hedge positions. For some Asian institutions, this is a non-starter. However, Page says most investors do allow derivatives if they are demonstrably for hedging, not speculation - and rebalancing transitions are short-term hedges, he argues. For those investors that simply can't handle derivatives, some tactics can be replicated with exchange-traded funds and other instruments.

Page says two questions continue to dominate investors' concerns. The first is how to protect their downside. This has become even more important in recent months, as investors are keen to defend their 2009 gains.

The second is liquidity. "How much cash does an investor need to raise if there's a worst-case scenario?" Page explains. To this end, State Street has developed a 'liquidity VaR' measure, using metrics similar to those behind VaR, but to give investors a sense of just how much cash they can muster in an emergency - to head off currency-hedging margin calls, capital calls or liabilities, such as policy or benefit payments.

Another product the firm is rolling out is its 'Turbulence Index', designed to help investors figure out when to increase or reduce the risk in their portfolio. Unlike the Vix volatility index, which many industry players say is not a leading indicator, Page says the Turbulence Index is able to warn investors of impending volatility spikes.

This potential canary in the coal mine constantly monitors correlations among asset classes, and boils them down to a single number. This simple measurement is meant to forewarn of changes in spread levels; for example, it can suggest if risk exposures like a currency carry trade are in peril.

Liquidity VaR and the Turbulence Index are certainly tools that investors can use, if they understand them properly. Such self-education will be important, because we know what happened the last time investors agreed that a single, simple number told them everything they needed to know.