Choose Your Tactical Asset Allocation Strategy Carefully
Morningstar last week advised that tactical asset allocation funds “failed—again.” That sounds ominous for this class of strategies, but a closer review suggests it’s misguided to pull the plug on the on idea that dynamically adjusting weights of asset classes has crashed and burned. As discussed below, the case for tactical asset allocation (TAA) is quite strong, assuming you’re an informed investor able and willing to separate the wheat from the chaff in this corner of portfolio management.
In the interest of full disclosure, your editor is not a disinterested observer. I’m an employee at The Milwaukee Company, the adviser to The Brinsmere Funds – a pair of risk-managed asset allocation ETFs. A particular type of TAA is a component of how we manage money. Note, too, that I wrote a book in this space: Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor. But you don’t have to rely on my view alone since there’s a deep pool of independent research and empirical evidence to support the case for using one flavor or another of TAA to manage portfolios.
Here are some of the key points that, collectively, strongly suggest that TAA is worthwhile and arguably essential for designing and managing asset allocation strategies.
Definitions. Let’s start with the basics. A productive discussion of TAA requires that we define our terms. TAA means different things to different people and so there’s a wide array of definitions, ranging from aggressive, shoot-for-the-moon strategies that rely on intuition and qualitative forecasts to relatively systematic, rules-based portfolios that tilt asset weights moderately. The closer you lean toward the latter, the stronger the case for TAA as a risk-management system for running portfolios. A key pitfall when debating TAA’s merits is assuming that analyzing the former offers reliable guidance on evaluating latter.
At a very high level, TAA can be defined as actively adjusting asset weights. But that doesn’t tell us much since almost every investor engages in some form of active asset allocation and does so in countless ways. Unless you’re initially setting weights, and forever letting the market adjust the mix – a true passive asset allocation strategy – some form of TAA prevails. But the details get complicated, which is why a simple top-down review of TAA tends to be unreliable at best, and deeply misinformed at worst.
Results vary—a lot. Depending on the type of TAA strategy under review, the performance and risk profile can look encouraging or ugly, or something in between. Relatively middling results aren’t uncommon. As a result, it’s crucial to understand what you’re analyzing in a corner of the investment world that offers strategy choices that run the gamut. In turn, average results from a pool of TAA strategies can be misleading. The TAA beta, if you will, can be unreliable in the extreme compared with reviewing, say, large-cap value or small-cap growth strategies. Trying to force fit a universe of TAA strategies that operate across a broad range of methodologies into a type of Morningstar style bucket can be deceptive. Morningstar reports that it’s “database includes a total of 243 unique funds in this category (not including multiple share classes), but 126 of those no longer exist.” I haven’t reviewed each of those funds and so I don’t know the type of risks they’re targeting or the methodologies they’re deploying. But what I do know is that taking a broad set of funds that are labeled TAA is a very different analytical exercise vs. carefully curating a set of funds in this space for assessing success and failure. If you prefer the former and avoid the latter, caveat emptor.