Asset allocation is often divided into two camps, strategic and tactical. These are two very different strategies with very different risks and returns.
Strategic asset allocation involves a fixed allocation to asset classes that is based on long-term views of market returns and long-term correlations among markets. Each portfolio is matched to an investor’s liabilities and financial goals. The allocation changes only when the liabilities or the goals change. Rebalancing is conducted occasionally to realign the portfolio with the original asset class targets. Some people call this buy and hold but in truth it is a buy, hold and rebalance strategy.
Tactical asset allocation involves more trading than an occasional rebalancing. An investor shifts asset class weightings around based on near-term expectations of market return. A portfolio may overweight an asset one month, underweight it the next, and be completely out of it by the third month. The idea is to outperform a strategic asset allocation by timing asset classes correctly.
It’s easy to estimate the performance of strategic asset allocation strategies. Simply compute the returns of each asset class and the amount allocated to each, then add up the results. Advisors like my firm that use this strategy don’t have anything to hide. Anyone can figure out performance history within a small margin of error providing you knew what the strategic allocation was.
Estimating the performance of tactical asset allocation strategies is infinitely more difficult. Although the advisors who use tactical asset allocation claim to take advantage of opportunities in the market, it’s difficult to measure or prove. First, it’s hard to pin them down on a benchmark (see this Forbes blog) and second, what they say they did in a portfolio isn’t always what happened because their performance results don’t add up to the story they told.
The performance of advisors who do tactical asset allocation is a hidden world. There isn’t much performance analysis available beyond what the advisors wish to provide. Fortunately, we can turn to indirect sources for reasonable estimates of advisor returns.
The hedge fund world is a good source for help in determining tactical asset allocation returns. The goal of a Macro fund is strikingly similar to the goal of advisors who attempt tactical asset allocation. They are both trying to find the next bright spot and avoid the weak spots. The idea is to take advantage of opportunities in the markets and add value to portfolios by doing so. Accordingly, if we check the performance of Macro fund managers, we should have a decent window into how all tactical asset allocation advisors performed.
According to a recent Wall Street Journal article, Tough Era for ‘Macro’ Funds, these tactical asset allocation strategies have had dismal returns. Overall, according to the HFRX Macro Index, the funds fell 2.2 percent in the first half compared to a gain of 5.0 percent for the S&P 500, a 3.4 percent gain for the MSCI All Country World Index, and 2.7 percent gain for the Barclays Aggregate Bond Market Index.
“Macro-fund managers have been tripped up by whiplash-induced swings in stocks, currencies and commodities, often brought about by the latest twists and turns of impossible to time political developments,” says Tom Lauricella of the Wall Street Journal.
Hedge fund managers are thought to be some of the smartest investment minds in the country. They have the most money for research and the most information available at their fingertips. If these masterminds are having difficulty with market timing, then it’s hard to imagine that the good-ole advisor down the road who is doing marketing timing with limited experience and resources is performing any better.
In my latest book, The Power of Passive Investing, I provide evidence that infers tactical asset allocation strategies underperform strategic asset allocation strategies by more than 2.0 percent per year over the long-term. My number seems relatively conservative given the latest Macro Fund manager results.
Tactical asset allocation is a big gamble that rarely pays off. Wise investors know that their highest probability for success in the markets is a strategic asset allocation strategy that uses low-cost index funds and ETFs. A strategic allocation, religiously applied, has the best chance for meeting your financial goals.Read Blog Disclosure Here