Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a

portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a ...

asset allocation Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment ...

. The goal of a TAA strategy is to improve the risk-adjusted returns of

passive management Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio. Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming m ...

investing.

Strategy descriptions

TAA strategies can be either discretionary or systematic.

Discretionary

In discretionary tactical asset allocation strategies, an investor modifies his asset allocation according to the valuation of the markets in which they are invested. Thus, someone who invested heavily in

stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...

s might reduce their position when they perceive that other securities, such as

bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemica ...

s, are poised to outperform stocks. Unlike stock picking, in which the investor predicts which individual stocks will perform well, tactical asset allocation involves only judgments of the future return of complete markets or sectors. As such, some practitioners perceive it as a natural supplement to

mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...

investing, including

investing.

Systematic

Systematic tactical asset allocation strategies use a quantitative investment model to systematically exploit inefficiencies or temporary imbalances in equilibrium values among different asset classes. They are often based on financial market anomalies (inefficiencies) that have occurred in the past and are supported by academic and practitioner research. For example, many systematic TAA strategies try to use quantitative

Trend Following Trend following or trend trading is a trading strategy according to which one should buy an asset when its price trend goes up, and sell when its trend goes down, expecting price movements to continue. There are a number of different techniques, ...

or Relative Strength techniques to produce

excess return Alpha is a measure of the active return on an investment, the performance of that investment compared with a suitable market index. An alpha of 1% means the investment's return on investment over a selected period of time was 1% better than the ...

s. These both aim to capitalize on

momentum In Newtonian mechanics, momentum (more specifically linear momentum or translational momentum) is the product of the mass and velocity of an object. It is a vector quantity, possessing a magnitude and a direction. If is an object's mass ...

, a well-known market anomaly.

Considerations

The

efficient-market hypothesis The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted b ...

would imply that tactical asset allocation cannot increase risk-adjusted returns, since markets are already efficiently priced. If a tactical approach were found that could increase returns without an increase in risk, investors would flock to that inefficiency, and the advantage would go away. Many investors do not accept this hypothesis, however, and believe that inefficiencies in the market persist and can be exploited. Many factors determine the success of a TAA strategy. The investor needs to have the necessary knowledge, practical investment skills, dedication, and discipline to design and/or execute a successful tactical strategy. The specific market anomalies on which the strategy is based may change or disappear in the future. Other factors such as risk tolerance,

market timing Market timing is the strategy of making buying or selling decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting fro ...

, portfolio size, investment expenses, etc. may also affect the portfolio performance.

Criticism

Investors who utilize the tactical asset allocation strategy generally want to

hedge A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoin ...

risk in a volatile market. However, Larry Swedroe of CBS MoneyWatch described the strategy as an attempt to time the market, and provides an excuse for managers to increase revenue from trading fees due to the frequent activity the strategy requires. In a study conducted by Morningstar, Inc., they examined the "net annualized return, standard deviation,

Sharpe ratio In finance, the Sharpe ratio (also known as the Sharpe index, the Sharpe measure, and the reward-to-variability ratio) measures the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for it ...

, and

maximum drawdown The drawdown is the measure of the decline from a historical peak in some variable (typically the cumulative profit or total open equity of a financial trading strategy). Somewhat more formally, if X(t), \; t \ge 0 is a stochastic process with X(0) ...

from July 31, 2010, to December 31, 2011," of 163 tactical funds. They concluded that only a small percentage of firms outperformed the

Vanguard The vanguard (also called the advance guard) is the leading part of an advancing military formation. It has a number of functions, including seeking out the enemy and securing ground in advance of the main force. History The vanguard derives f ...

Balanced

Index Index (or its plural form indices) may refer to: Arts, entertainment, and media Fictional entities * Index (''A Certain Magical Index''), a character in the light novel series ''A Certain Magical Index'' * The Index, an item on a Halo megastru ...

, the exceptions being

PIMCO PIMCO (Pacific Investment Management Company, LLC) is an American investment management firm focusing on active fixed income management worldwide. PIMCO manages investments in many asset classes such as fixed income, equities, commodities, ass ...

and GMO (

Grantham Grantham () is a market and industrial town in the South Kesteven district of Lincolnshire, England, situated on the banks of the River Witham and bounded to the west by the A1 road. It lies some 23 miles (37 km) south of the Lincoln a ...

, Mayo, Van Otterloo) Global Asset Allocation. Updated to June 2013, they found that 20 percent of funds beat the Vanguard Balanced Index Fund, and just four had a better Sharpe ratio.

References

Sources

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External links

6 Asset Allocation Strategies that Work

Interactive asset allocation toolbox for applying various portfolio construction techniques
{{DEFAULTSORT:Tactical Asset Allocation Investment management Financial risk management