Tuesday, September 15, 2015

Beware Tactical Asset Allocation?

ETF.com recently posted an article entitled

Beware Tactical Asset Allocation

The article brought up a couple of great points:

1. Tactical Asset Allocation (TAA) is really just market timing
2. Very few TAA funds as measured by Morningstar beat the benchmark of a balanced fund (60% Stocks/40% Bonds)

Market timers try to predict the stock market.  Their goal will be to try to get in at the bottom and out at the top.  True practitioners of TAA know that nobody can predict the market, but you can react to it.  Instead of getting out at the top, you get out before bad turns into really bad.  So instead of losing 30% in a bear market you might lose 5%.  They also try to get in once a rally has started.  Who cares if you miss some of the initial upside if you have missed most of the downside.

Benchmarking tactical strategies is also difficult, a 60/40 buy and hold fund is not a suitable benchmark for a tactical strategy.  Furthermore, Morningstar puts funds that it can't really figure out what they do into the tactical benchmark.  It is hard to say how many of the funds they call tactical are truly tactical.  Finally, saying a fund is tactical is like saying a fund invests in equities---do they buy small cap, large cap, international, growth, value, etc?  There are a number of different tactical methodologies, you cannot simply lump them together under tactical.

It is true that many tactical managers have underperformed a buy and hold benchmark during the bull market, especially throwing in last year's choppy market which is the worst type of market for tactical,  it would be interesting to see the same analysis during a full market cycle that contains a bull and a bear.  Most tactical strategies are designed to get a decent upside capture with very little downside capture.  You can't just use a bull market to evaluate this.

Nobody knows what the market will do from here on out but most could agree we are closer to the top than we are to the bottom.  Given where we are in the market cycle it would seem much more prudent for investors to utilize tactical funds for some, or all, of their portfolio instead of riding the market down with buy and hold investments.