Sunday, December 20, 2015

The Current Market Environment and Implications for Tactical Asset Allocation Part II

In the fist article in this series we talked about some of the implications of this new market environment with choppy markets and V shaped corrections.  Time will tell whether this type of market environment is the "new normal", something that is likely to happen more frequently, or an anomaly that is unlikely to happen very often.  It is possible that this type of market is an anomaly but if it isn't then we need to be prepared.  Most tactical strategies are built around momentum.  Traditional momentum methodologies will work great in straight up or down markets but they struggle in choppy markets.  Designing robust strategies that can generate attractive returns in choppy markets without sacrificing anything in straight up and down markets is challenging but not impossible.  Here are a few steps that practioners can take:

1. Deal with rebalance date risk----Instead of rebalancing a strategy all on one day, it can be broken up over perhaps 5 days where 20% of the portfolio is rebalanced each day.  This can minimize the risk of shifting an entire portfolio on one random day.

2. Use multiple, uncorrelated methodologies with some sort of optimization approach to decide allocations to each---Instead of diversifying by asset class you should diversify by tactical methodology.  An optimization approach like maximum Sharpe, maximum return, minimum volatility, or regime switching could be used to determine methodology allocation.  Using a rebalance date risk strategy you would cycle in and out of methodologies.

3. Overemphasize counter trend methodologies over momentum methodologies---counter trend methodologies are much more suitable for choppy markets and a well designed counter trend methodology shouldn't give up much, if anything, in an up market.  Counter trend methodologies using different logic and different markets should be used.

4.  Use models that can have a short side---Counter trend methodologies buy weakness and sell strength.  In a bear market or major correction short term weakness can continue for a time without any short term strength, locking the counter trend methodology in.  While we do not believe in going net short, we can combine long only counter trend methodologies with other models that can go short to reduce total equity exposure in bear markets and corrections.

5. Use very short term momentum methodologies to capture major upside in V shaped corrections---V shaped corrections are characterized by quick and sharp downturns followed by equally quick and sharp upturns.  Momentum methodologies with traditional lookbacks will not be able to perform well during these corrections.  Short term momentum methodologies can get out near the top and in near the bottom.  However, these types of methodologies are significantly flawed in other types of environments.  The optimization approach should ensure that you can cycle into these methodologies during market environments that are more conducive and out of them in other market environments.

Using these five steps in strategy design can create robust tactical strategies that can perform well in any type of market environment. 

Saturday, December 19, 2015

Some More Nails in the Mutual Fund Coffin

Two things happened this month that hammered a couple of more nails into mutual fund coffin.  First we saw the Third Avenue announced that they are suspending investor redemptions from their junk bond fund.  They way mutual funds work if an investor wants to redeem shares then the mutual fund manager either uses cash on hand or sells securities to send the investor cash.  Under normal circumstances this is no problem, funds keep cash and typically own liquid securities that can easily be cashed in.  However, under extraordinary circumstances, like when a fund owns junk bonds that are tanking and not easy to sell and when more investors than normal want cash, that can create a problem.  That is what happened with Third Avenue, they either couldn't, or didn't want to sell bonds at a steep discount so they locked shareholders in.  ETFs work differently.  Normally, when an investor goes to sell they don't sell to the ETF issuer, they sell to a buyer on the market.  If an investor, or investors, want to liquidate large amounts then a trading firm called an authorized participant (AP) sends a request to redeem to the fund custodian.  Instead of getting cash they get a basket of securities that the fund owns and it is their responsibility to sell it on the open market.  If a junk bond ETF ran into trouble like Third Avenue investors could still sell, however the APs would probably extract some cost for ending up with a basket of illiquid securities.  At least as an ETF investors would have the choice of selling at a discount or holding on.  Now they have no choice.

The second thing that happened is that Eaton Vance announced the launch of Next Shares.  These are non-transparent ETFs that will allow actively managed mutual funds to offer ETF versions of their funds without everyone knowing what they own.  Eaton Vance's launch will be followed by a number of other companies.  Wall Street still has to work out the technology to trade these but they will be cheaper and better than the mutual fund versions.  Any shareholder in an actively managed fund that has a Next Share version who doesn't have built up capital gains should switch from the fund to the ETF.

Friday, November 20, 2015

The Current Market Environment and Implications for Tactical Asset Allocation

The past two years have been difficult ones for tactical asset allocation (TAA).  The continual V shaped corrections and a lack of trend in any asset class has caused TAA strategies to lag the US market.  On the plus side, TAA strategies have outperformed global asset classes and since we are probably closer to the top of the market than the bottom we are probably very close to a point where TAA will really show its value when we hit a bear market.  Any investment strategy will have a market environment it doesn't work as well in.  For traditional asset allocation it is a bear market and markets where most asset classes are not doing well.  For TAA it is a choppy market.  I would much rather talk to clients about underperformance in a choppy market than try to justify being down 30% while the market is down 40%.  Putting all that aside we need to consider some important issues about the past two years as it relates to the future of TAA. 

The questions that practioners should be asking now are:

1. Is the choppiness of the past couple of years a fluke that is not likely to persist
2. Is the choppiness of the past couple of years the "new normal"

The answer to both of those questions is probably no, but we need to be better prepared for years like this.  In thinking through this problem a number of important thoughts come to mind.

1. We need to take backtests with a grain of salt.  We can do walk forward testing, 3D analysis, etc to make sure we are not curve fitting but any long term backtest that shows great results doesn't have a lot of relevance in today's markets.  On the flip side, any backtest that handles these markets and struggles in trending markets is just curve fitting and also doomed to failure.  Backtesting systems is still important but we need to apply a lot of forward looking common sense.

2. All in or all out models might not be optimal.  Traditionally, TAA models were all in or all  out.  For example, a system that bought the S&P 500 when it is above its 200 day moving average would move 100% of its portfolio to stocks or cash on one fixed day a month.  That works fine when you have strong trends but fails miserably in  a choppy market. 

3. Rebalance date risk must be taken into account.  In the example above the moving average system would rebalance on one fixed day.  Sometimes it will be a perfect day to rebalance, other times it won't.  Over time this should even out, but in a choppy market with large moves missing something by a day or two can be devastating. 

4. TAA strategies need to include multiple methodologies.  In a trending market just about everything works all the time.  In a choppy market different methodologies will cycle in and out of favor.  Just like asset allocators diversify by asset class, TAA practioners need to diversify by tactical methodology.  Just like Modern Portfolio Theory (MPT) optimizes asset classes, TAA can optimize tactical methodologies.  With MPT asset classes that could never stand alone in a portfolio can be a strong part of a diversified portfolio.  The same approach can work with TAA, methodologies that might not be ideal for an entire portfolio can be part of a well balanced strategy.

5. TAA strategies need to include some sort of counter trend methodology.  A TAA strategy is never going to be nimble enough to turn on a dime in a V shaped recovery, momentum and trend following models take time to move from safe havens back into the market.  Counter trend methodologies have no such limitations and can get in at short term market bottoms and out at short term market tops.  Having these methodologies as part of a TAA strategy will allow the portfolio to get invested once a recovery has started.

We can either put our heads in the sand and hope that the choppiness of the past couple of years is just a fluke or we can adapt our models so that they not only work in trending markets but they can also do fine in a choppy market.

Monday, November 16, 2015

Using Reblance Date Diversification to Reduce Rebalancing Risk

Tactical methodologies have a number of different factors which influence their results.  Making a small change to any factor can drastically change the results of the methodology.  For example, most trend following methodologies have a lookback period and a rebalancing frequency.  The lookback period can either be long or short and the rebalancing frequency could be monthly, weekly quarterly, daily, etc.  In a previous post we talked about the concept of tactical duration where longer lookback periods and rebalancing frequency models will be less sensitive to market movements and shorter term models will be more sensitive.  We also recommened that multiple lookbacks and rebalancing frequencies be combined, in either an approach that allocates to all of them or in an approach that dynamically shifts based on the market environment.  Doing this smoothes out the return stream but it does very little to reduce the risk of when you actually rebalance.


Any strategy that rebalances must deal with rebalancing risk.  Take two identical 60% stock and 40% bond strategies that both rebalance annually.  Strategy 1 rebalances on the first trading day of the year and strategy 2 rebalances on the second trading day of the year.  Assume that stocks had a good year and bonds had a horrible year so both strategies end the year 80/20 and must rebalance back to 60/40.  Strategy 1 sells 20% stocks and buys 20% bonds on the first trading day of the year.  If on the second trading day of the year the market crashes then strategy 1 will substantially outperform strategy 2 solely based on the rebalance date.  Since tactical strategies often have larger and more frequent rebalancing this risk is especially important to address.


This risk can be reduced by using rebalance date diversification.  The concept is fairly simple, lets take a tactical model that rebalances monthly on the last trading day of the month.  This type of model obviously has a great degree of rebalancing risk as it has 12 fixed rebalance periods per year.  A way to smooth this out would be to split the model into 4 equally weighted portfolios.  Portfolio 1 would rebalance after the first week of the month, portfolio 2 would rebalance on the second week, and so on.  The final portfolio would be the average of these weekly rebalances. 

Of course rebalancing risk can hurt or help performance.  In the example above strategy 1 would not have taken issue with the choice or rebalance date.  However, not diversifying rebalance dates subjects portfolios to large swings that can go either way.  Using rebalance date diversification can smooth these swings out and provide for a better investor experience.





Thursday, November 5, 2015

Tactical Duration

Investors are aware of the term duration as applied to bonds.  Duration is the measure of how sensitive a bond will be to moves in interest rates.  Typically, the longer term the bond is, the more sensitive to changes in rates.  Shorter term bonds are less sensitive to changes in rates.  Tactical methodologies also have duration in relation to how sensitive they will be to market movements.  Unlike bonds however, short term strategies have a high tactical duration, while long term strategies have a lower tactical duration.

When implementing a tactical methodology you are often looking back over a period of time to judge the trend of an asset class.  You also have to decide how often you do this lookback and rebalance your methodology.  Short term lookbacks and/or short term rebalancing make tactical strategies very sensitive to short term market shifts, creating a high tactical duration.  Longer term lookbacks and/or longer term rebalancing make tactical strategies much less sensitive to day to day market movements, creating a low tactical duration. For example, assume we wanted to create a moving average crossing system to trade the S&P 500.  It would generate a buy signal when the S&P crossed a moving average to the upside and a sell signal when it crossed a moving average to the downside.  You have two variables to your model---which moving average to choose, and how often to do the analysis.  If you pick a longer term moving average and a longer term analysis the model will be less sensitive to market moves.  A short term moving average with a shorter term analysis will be more sensitive.

A 200 day moving average with a daily rebalance applied to the market moves we saw during August, September and October would have gotten you out sometime near the end of August and would have gotten you back in near the end of October.  Assuming you were good with your trading you would have missed much of the decline and also much of the rally, but you would have ended up right about where you started, either a small loss or a small gain.  If instead of a daily rebalance you rebalanced at month end you would have gotten out at the end of August and back in at the end of October.  That would create a much different outcome as you would have experienced most of the loss and none of the rebound.

If you had decided to use a 50 day moving average and a daily rebalance you would have gotten out sooner and missed more of the loss.  You also would have gotten back in much sooner and experienced a good chunk of the gain.  However, if you had decided to rebalance this model monthly then it would have generated the same results as the monthly 200 day moving average.

During the most recent market decline the 50 day moving average with a daily rebalance would have generated the best results by far. Does that mean it is the best methodology?  No, it worked the best in that situation, but in other scenarios different combinations would have worked best.  During the market decline we had in January and subsequent rally in February a 50 day moving average with a daily rebalance wouldn't have done as well.  It would have exited the market three times during January, only to get back in each time at higher prices.  A 200 day moving average would have been much less sensitive, it would have stayed in during the decline in January and then experienced the entire rebound in February.

Some tactical practioners use methodologies based on some sort of fundamentals.  For example, we have a tactical model that looks at S&P 500 earnings.  Because fundamental factors are much less noisy and move much slower than market prices these types of methodologies tend to have the least sensitivity to market moves, and therefore have the lowest tactical duration.

So methodologies that have lower tactical duration (longer term lookbacks and/or longer term rebalancing or based on fundamentals) work best in certain markets while methodologies with higher tactical duration (shorter term lookbacks and/or shorter term rebalancing) work best in others.  Which ones should practioners and investors use?  Since no tactical duration is optimal the answer is to use all of them.  There are two ways to implement this.  Just like investors use laddered or barbell bond portfolios to lessen the impact of any one duration, investors can ladder or barbell tactical methodologies, combining different tactical durations.  More sophisticated investors could use an optimization approach that determines which duration is working best in a certain market and skew allocations to that methodology.

Whatever investors choose they need to be aware that different tactical methodologies have different sensitivities to market moves and need to allocate their portfolios accordingly.

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.

Wednesday, August 19, 2015

How Counter Trend Models Can Adapt to Changing Market Environments

Trend following methodologies attempt to buy into market strength and sell into market weakness.  Counter trend methodologies do the opposite, buying into market weakness and selling into market strength.  Trend following works under the premise that investments tend to trend over time and works best over intermediate term time frames (1-6 months).  Counter trend models work under the premise that over shorter time periods (daily to weekly) markets are dominated by noise, fear, and greed, causing them to overshoot to the upside and downside before snapping back to equilibrium.

Counter trend models can add needed diversification to tactical portfolios dominated by trend following models.  Trend following works extremely well in straight up or down markets, but doesn't work is well in choppy markets or equity peaks.  Trend following models also can't participate in bear market rallies.  Counter trend models don't work as well in straight up or down markets but do very well in choppy markets and equity peaks.  They can also participate in bear market rallies.  

The basic idea behind counter trend models is to use some measure to determine whether a market is oversold, overbought, or at equilibrium.  These could be static models that perhaps buy on n day lows and sell on n day highs or they could use some sort of dynamic logic.  Because markets are dynamic I have not seen static counter trend models work well over long periods of time.  Dynamic models are usually a much better option.  

There are two market factors that will determine how a counter trend model will react and perform, noise and volatility.  Noise is a measure of whether the market has a direction or not, while volatility measures the extent of up and down moves.  Market noise will determine how well a counter trend model will perform while volatility will determine what types of market moves a counter trend model will need for it to determine whether a market is overbought or oversold.  Counter trend models tend to work best in markets that are noisy and volatile.  They tend to work worst in markets that have low noise and high volatility (trend following models work best in this environment).   

So far in 2015 we have had an extremely noisy market with no direction, but volatility has been low.   In this environment---high noise, low volatility---an adaptive counter trend model wouldn't need large moves to determine whether the market is overbought or oversold and it could move in and out of noisy markets very frequently.  This is what we have seen in our counter trend models this year.  In a high volatility market, adaptive models would need larger changes to move in and out of markets.  

The Smart Beta Dilemma

The debate about whether smart beta strategies add value vs. market cap weighted indices will probably never end.  Smart beta strategies continue to launch with impressive backtested results that show outperformance over market cap weight.  The main questions revolve around whether those backtests are curve fitting and/or anomalies and whether that outperformance can persist.

If you are a long term buy and hold asset allocator then this presents a problem.  You are benchmarked against market cap weighted indices so any allocation to smart beta involves risk of underperformance.  You have to be sold on the backtest and the idea that any outperformance will be persistent.  If you are right you might add alpha, if you are wrong then you have a problem.

Tactical asset allocators don't have that problem.  Whether any smart beta idea is an anomaly or not isn't as relevant if you are not going to buy and hold something for ever.  The only relevant issue is whether or not a smart beta idea has periods where it outperforms a relevant market cap weighted index and how volatile that performance is.  Using relative strength or absolute momentum models of smart beta along with market cap weighted products allows the tactical investor to switch back and forth between smart beta and market cap weight (or cash in the case of absolute momentum).  Whether the outperformance will persist over the long term isn't relevant as long as it persists long enough for the tactical investor to make money and isn't so volatile that it moves down faster than a tactical model can exit.  

For the tactical investor, smart beta is another tool in the toolbox.  Maybe smart beta strategies are better than  market cap weighted indices, maybe they are not, but they do give tactical investors another set of assets to use in their models.

Wednesday, July 29, 2015

Factor Return Dispersion

So far in 2015 we have seen much more dispersion in the return of different factors---low volatility, momentum, value, increasing dividends, etc.  As you can see from the chart below it didn't really matter what factor you chose in 2014, all of them did well, except for size (small cap).  This year has show much more dispersion, from momentum (MTUM ETF up 9%) to high beta (SPHB down 5.78%):

Factor ETF 2014 YTD 7/28/15
Value RPV 12.21% -3.17%
Momentum MTUM 14.62% 9.00%
Dividends NOBL 15.54% 0.81%
Quality QUAL 11.70% 4.41%
Low Vol USMV 16.33% 3.64%
High Beta SPHB 12.68% -5.78%
Size IJR 5.85% 1.68%
Standard Deviation of Returns 3.49% 4.91%

Source: Morningstar

We already have a factor rotation model in TUTT and will be expanding the universe and adding a bit of factor rotation to our Core Satellite Strategies to take advantage of this dispersion.  The Core Satellite Strategies will keep a fixed 60% allocation to factor/smart beta ETFs but now they will incorporate a rotation model that can take more advantage of dispersion among factors.

Friday, July 24, 2015

Factor Investing--The Future of Traditional and Tactical Asset Allocation

Traditional equity research has always thought that most of a portfolio's returns can be explained by the portfolio's asset allocation.  This has then been taken to mean how much is in specific investment styles---small cap stocks, large cap stocks, growth stocks, value stocks, etc.  Newer research now shows that investment results can be explained by certain factors that have outperformed the market over time.  A factor is any characteristic shared by a group of stocks that can explain their returns and risk. There are a number of different factors that have historically earned a risk premium---value, size, momentum, quality, low volatility, etc.

Value Factor---Stocks that have low prices compared to their fundamental value

Size Factor--Stocks with smaller market capitilizations

Momentum Factor---Stocks with higher price momentum

Low Volatility Factor--Stocks with lower volatility (Beta)

Quality Factor--Stocks with low debt, stable earnings, and other quality metrics. 

There is much speculation about why factor outperformance exists and whether it will persist.  The reason some factors tend to outperform can be easily grasped.  For example the value factor is most likely a combination of the fact that if you buy something at a lower price and hold onto it for a long time then it should do better then something you buy at a high price.  You could also argue that value stocks are riskier than growth stocks since they have a more uncertain future and markets compensate investors for taking more risk.  The size factor can also probably be boiled down to risk and also smaller stock have more room to grow then larger stocks.  Momentum comes down to investor psychology.  Investors tend to pile into what ever is going up, creating trends that persist.  The quality factor makes sense and companies with strong financials should do better than those with weaker financials.  I am not quite sold on the low volatility factor.

For practitioners who still follow a traditional asset allocation approach  this new research presents a way to take a flawed investment philosophy and make it less flawed.  Instead of trying to optimize  portfolios by investment styles you could optimize exposure to factors.  Investment styles will still have factor exposure but it will not be pure.  For example a market cap weighted index of value stocks will still hold some stocks that are more blends between value and growth.  If these historical factor risk premiums persist then a well thought out factor based portfolio should outperform style based portfolios.

For practitioners of tactical asset allocation factor investing provides another powerful tool.  Historically, many tactical strategies have focused on style or sector rotation as a way to be positioned in the strongest style or sector.  This type of analysis can be either combined or replaced by factor rotation to try to be positioned in the strongest factor.  If the academic research is right and stock market performance is driven by factors then this should be a much more powerful approach going forward as it will a purer approach to capturing whatever factor is currently in vogue.  Over time, factors have shown a great degree of cyclicality.  Each factor has had a least a two year or more period of underperformance vs. market cap weighted indices but they are not completely correlated from an underwater basis.  This cyclicality and lack of underwater correlation also lends itself well to a tactical approach.

Monday, June 29, 2015

I am Getting Sick of this Ongoing Greek Crisis

Back in the old days if you couldn't  pay your bills you went bankrupt.  The people who didn't do their due diligence and loaned you money would have to work it out in the courts.  Today the Fed and the ECB have gone so far down the bailout rabbit hole that nobody is allowed to go bankrupt.  This has probably been one of the reasons that the bull market has gone on so long and been so strong.  When you know that the central banks will bail everybody out then you can take a ton of risk and not have to worry about the downside.  But what happens when everyone takes a ton of risk for a long time?  The eventual crash gets really ugly.  Kind of reminds me of the mortgage crisis in 2008 and the tech bubble of 2000.  The ECB can keep kicking the can down the road on Greece but the road eventually becomes a dead end and you have to deal with the fact that structurally, the Greek economy is different, and at the end of the day they probably just can't pay their bills.   This has been going on now for a number of years and I am getting tired of it.  Letting Greece go under would create some short term volatility but that would eventually subside and we could get on with business as usual.  Investors would also be reminded that their is no such thing as risk free and that they still need to do their homework when decided what to invest in.  Short term there would be some pain, longer term things would be better.  Unfortunately, politicians think about the short term because of elections, and ignore the long term when they are likely to be out of office any way.  

Tuesday, June 2, 2015

A Disaster Waiting to Happen?

If you earn a state pension or live in a state that has a shortfall in their pension then you need to pay attention to pension obligation bonds.

Borrowing to Replenish Depleted Pensions

The idea is that a state issues bonds, borrowing money from bondholders, and invests the bonds in their depleted pensions.  To make the math work the pensions invest the money relatively aggressively and are projecting that they will earn more on the invested money than they will pay out on the bond interest.  If the next six years in the stock market look like the past six years then this will all end well.  If they don't, then it could make a bad problem really bad.  Kind of like what happens when you borrow from one credit card to pay off another credit card---usually things don't work out that well.

Nobody knows what the market is going to do, but we can learn a lot from history and at least judge the odds of this strategy being successful.  Looking at current stock market valuations based on historical standards, whenever US markets have been at this high a valuation the next 10 years have been mediocre at best.  One of the times when people start bringing out the this time is different argument they will be right, states better hope this time really is different.

Wednesday, May 13, 2015

Targeting Portfolio Volatility

Volatility is an important factor in designing portfolios for clients.  First off, volatility tends to be negatively correlated with returns, meaning when volatility of an asset increases returns tend to decrease.  Second, volatility can hamper the "investor experience".  We have talked about the idea of optimizing investor experience in the past.  It basically means that at the end of some horizon the investor has earned as much as reasonably possibly while being able to tolerate the ride.  When volatility is high the ride is bumpy and becomes much less tolerable.

In traditional portfolio construction volatility is assumed to be static, today's volatility is tomorrow's volatility.  So an investor might construct a 60/40 stock/bond portfolio, using the bonds to dampen volatility.  That same investor might be willing to assume more volatility than a 60/40 portfolio would deliver in a stable environment but not willing to assume the level of volatility the same portfolio would have during a volatile environment, so the 60/40 represents a compromise.  This compromise causes the investor to not make as much as they could during a low volatility period and causes the investor to experience more volatility than they are comfortable with during a highly volatile period.  This eventually leads to a poor investor experience.

Targeting portfolio volatility is a much better approach.  For example, in the same 60/40 portfolio the stocks would be more volatile than the bonds.  Assume you want to target an annualized level of volatility, for example 12%.  During times when stocks are not volatile the percentage of stocks would increase vs. bonds.  During times when stocks are volatile their allocation would decrease vs. bonds.  Instead of a static portfolio the investor would have more in stocks during low volatility environments, setting them up for more potential returns, and would have less in stocks during high volatility environments, lessening the bumpiness of the ride and perhaps avoiding major drawdown.

Wednesday, April 15, 2015

The Biggest Mistake Investors and Advisers Make

Study after study of the money managers who have had the best long term performance shows the same thing----while the money managers made a lot of money over time, the average client lost money.  This isn't some sort of Ponzi scheme, it is because investors and advisers tend to buy into money managers or strategies when they are doing well and sell out when they are doing poorly.

Wall Street does a good job of hammering home the point that past performance doesn't predict future results.  Regardless of how bold that statement is on every marketing piece people still believe the most recent investment past will equal the future.  Last year's top money manager or strategy will be next year's top performer.  Last year's bottom performer will be next year's bottom performer.  This ignores two basic facts about how markets work----investment strategies cycle in and out of favor and everything eventually mean reverts.

It is no secret that investment styles and strategies cycle in and out of favor.  In the asset allocation world there are times when value outperforms growth and times when growth outperforms value.  There are times when small stocks outperform large stocks and times when large stocks outperform small stocks.  In the tactical world there are times when momentum strategies do well and times when the don't.  There are markets that are perfect for counter trend strategies and markets that aren't.  The best investment strategies might crush whatever benchmark you use over time, but day to day, week to week, month to month, there will be times it underperforms.  If investors are constantly getting out during the underperforming periods they usually get out of one strategy at the wrong time and into another at the wrong time.

Investments are also mean reverting.  What goes up big eventually goes down to more normal levels. This happens over and over again with asset classes and strategies---Gold, Apple, Biotech, Japan, etc. Investors always like to buy into what is hot.

We see this in our investment strategies, most new client money flow goes into whatever strategy has had the best recent performance.

I get it, it is much easier for someone to reconcile buying into what is hot than it is to buy into what is not.  But if you constantly rotate from what isn't  hot to what is then you are asking for mediocre investment results at best.  Instead of focusing on buying past performance focus on buying into a process that should produce the best results (tolerable volatility and the best possible returns) going forward and stick with it through the inevitable ups and downs.

Sunday, April 5, 2015

Avoiding Momentum Head Fakes

Momentum is an extremely powerful investment strategy.  The basic idea is that objects that are in motion tend to stay in motion---when stocks are strong they tend to stay strong, when bonds are strong they tend to stay strong, etc.

Momentum investing is based on individual investor psychology. When an asset class starts to move from a downtrend to an uptrend generally the "smart money" gets in first.  This is followed by the "not as smart, but still pretty smart money", then the "still pretty smart, but not quite as smart money", and so on and so forth until the inexperienced investor gets in somewhere near the top.  This cycle generally plays out long enough for the momentum investor to get in once the uptrend has started, get out once a downtrend is established, and still make a lot of money on the trade.

Hundreds of research papers have been written proving that momentum works across asset classes and across time frames.  However, just like any investment strategy, momentum can cycle in and out of favor.  The worst type of market for a momentum strategy is a choppy one, which can result in a number of momentum head fakes.  In a choppy market an asset class might move up for one period, causing a momentum investor to enter, and then move down the next period, causing the momentum investor to exit with a loss.  Repeat this cycle over a year or so and it can be a pretty frustrating experience for investors as they always seem to be buying high and selling low.

Every investment strategy has an Achilles heal, for buy and hold it is a bear market, for momentum it is a choppy market like the kind we experienced in 2014.  This presents a particular problem for momentum strategies as investors tend to be more forgiving of losses when the market is down, misery loves company.  However, they tend to be less forgiving of losses when the market is going up.  A negative year for a momentum strategy while the overall market is up can cause investors to jump ship and miss out on the future benefits of momentum.

The answer to this problem comes from diversification.  Not diversification by asset class---large cap stocks, small cap stocks, international stocks, value, growth, etc, but diversification by methodology:

Option 1: A Core/Satellite Approach---In Core/Satellite approach the investor would have a fixed core of a portfolio surrounded by a momentum based overlay.  In a choppy market the momentum overlay would still be subjected to momentum head fakes but the fixed core would remain invested.  In a bear market the investor would be exposed to higher drawdowns but the losses would be shifted to a down market which is psychologically more easy to tolerate than losses in an up market.

Option 2: Multiple Momentum Approaches---Many tactical managers try to optimize the one best momentum methodology.  A smarter approach would be to combine multiple, uncorrelated momentum methodologies together.  The idea would be that when one is being subjected to momentum head fakes the others are not.

Just because momentum strategies struggled in 2014 doesn't invalidate their effectiveness.  Every investment strategy has a market environment that it will struggle in and momentum did exactly what it was supposed to do in 2014.  As practitioners we need to constantly innovate to address these issues as much as we can to ensure the best possible investment experience for clients.


Thursday, April 2, 2015

ETF Trading Basics

Now that our ETF is out we have been getting a lot of questions about how to trade ETFs.  Here are some basic guidelines:

1. Volume has nothing to do with liquidity--The ability to trade an ETF has nothing to do with volume, it is all based on the liquidity of the underlying basket.  

2. Know the fair value of the ETF when you want to trade it---Quote systems only show the last trade, so if the ETF last traded at 10am and you want to place a trade at 3pm the price you see will be old.  A better way to gauge the value of the ETF is either looking at the Indicative Value (you will need some sort of advanced quote screen for this), or the bid/ask spread, which can be found on Yahoo Finance.

3. Try to avoid trading during the first and last 15 minutes of the trading day--During the open in takes market makers a bit to figure out the prices of all the underlying securities in an ETF.  During that time bid/ask spreads are likely to be wider.  At the end of the day you can see a lot of order imbalances that can also impact spreads.

4. Try to avoid market orders---Market orders put you at the mercy of the market, you are better off placing limit orders.  We can help you decide where to place your limits.

5. Call your block desk on trades over 5,000 shares---Larger trades are better facilitated through your custodians block desk.  They will reach out to various market makers and come back to you with the best price.

Thursday, March 26, 2015

How The Bull Market Might End

Yesterday I was on CNBC talking about how bull markets die slowly and how the sell off was not the beginning of the end, yet:

http://video.cnbc.com/gallery/?video=3000364927

What yesterday might have been though is a sneak peak at what the end will look like.  In this Fed induced bubble bad economic news should be good as it means that Fed tightening will probably be pushed out.  When bad economic news is bad, then that is bad, because it means that the market thinks the Fed might be out of bullets.  If the Fed has exhausted their playbook and we are still headed towards a recession then we have a problem.  Over the past few years we have had a bunch of V shaped moves in the market, something knocks us down but we know the Fed has our back so the market rallies back up.  If we know the Fed has our back but we also don't believe they have any options left then one day we have a decline that doesn't rally back.

As I said on CNBC this bull market will die slowly, but all bull markets eventually die.  Investors who are prepared will be fine, those who have come to believe "this time is different" will get hurt like they always do.

Sunday, March 22, 2015

What is Better---Index Funds or Active Managers?

The active and passive investment shops always argue it out over what is better---active money managers or indexing.

I just read a paper from Vanguard that, as you would expect, makes the case for index funds:

The Case For Indexing

Put alongside the paper from Ted Theodore about there being better times to be active and better times to be passive it brings up an interesting idea:

Dig We Must

What if they are both right?  There are times when stocks are uncorrelated that a good stock picker (someone who is not just hugging an index) can add some real value.  There are also times when stocks are very correlated where it is much harder for an active manager to add value.   Given this, it is very easy for both sides to data mine and pick out the times when there way outperformed as proof that one way is better than another.

However, this argument ignores the 800 pound gorilla in the room about what happens when the market goes down?  Neither active stock pickers or passive indexes will protect investors from market declines.

The better approach could be twofold:

1. Instead of active or passive how about smart beta?  Smart beta strategies fall somewhere in between, they are passive because a computer is picking the stocks just like an index fund, but they have a semblance of being active because the portfolio manager is using some sort of formula other than simple market cap weighting to pick stocks.  The smart beta strategies out there today have all been backtested and show to beat the market.  Yes, I know that nobody has ever seen a bad backtest so time will tell whether these strategies are robust going forward.  We think they will be because we believe they benefit from a value and size effect which should persist.

2. You need a tactical overlay.  Smart beta may beat the market over time but it won't protect you when it crashes either.  A tactical overlay on top of a smart beta strategy makes smart beta smarter.

Friday, March 20, 2015

Is It a Stock Pickers Market or a Global Macro Market?

If you watch financial news enough you will hear someone come on and talk about how the current market is for stock pickers, but what does that mean?  Just watching the market day by day you see times when it seems like all stocks go up or down together and you also see times when there are a bunch of divergences.  It would seem to make sense that during times when stocks are moving together that there isn't a ton of value trying to pick individual stocks.  On the flip side, it would seem that during times when there is a lot of divergences between stocks that stock picking would have much more value.  As a money manager we have individual stock strategies and strategies that just buy broad market based ETFs.  If we could identify times when our stock strategies were likely to outperform and times when it made more sense to concentrate on broad markets, that could be very useful.

Ted Theodore over at QAS just wrote a real interesting piece on how to measure this.

ETF Strategist-Dig We Must

Saturday, March 14, 2015

Why Smart Beta Strategies Work---It's Not What You Think

Smart Beta strategies are hot.  Go to any ETF conference and the majority of presentations will be about Smart Beta.  Smart Beta is any type of indexing methodology that is not market cap weighted, in an index like the S&P 500 companies are weighted by how large they are.  A Smart Beta approach to the S&P 500 would weight companies differently---equal weight, fundamental weight, low beta, high beta, etc.

It makes sense that Smart Beta is hot right now, ETFs are the future of asset management but we don't need another market cap weighted index.  So if you are going to issue a new ETF it has to be something different.  Add in the fact that the research shows that just about any other way to weight an index beats market cap weighting over time.

The million dollar question is why does Smart Beta outperform market cap weighting and will it persist?  One idea why is simple, curve fitting.  With computer technology you can find a bunch of anomalies that beat the market.  To guard against this you need to start with a valid premise that should work, and then test it to see if it does.  For example, weighting companies by fundamental factors, meaning the companies in the best shape get a larger weight in the index and the companies in the worst shape get a lower weight, should beat simple market cap weighting.  You can then test it and see what the results are.

The link below it a video from Rob Arnott talking about Smart Beta, it is a couple of years old but makes an interesting point about why Smart Beta strategies likely outperform.

http://www.morningstar.com/advisor/v/82453051/arnott-why-cap-weighted-indexing-is-flawed.htm

He took a look at a bunch of different Smart Beta approaches and found that they beat market cap weighting.   He then took the opposite of those approaches and found that they also beat market cap weighting.  On the surface this makes no sense.  For example, if overweighting low beta stocks beats market cap weighting because their is something uniquely powerful about low beta stocks, the the inverse, overweighting high beta stocks, shouldn't beat market cap weighting, but it does.

The answer most likely is that Smart Beta strategies, regardless of how they are constructed, encompass two tilts---value and size---that do better than market cap weighting.  In a market cap weighted index you are always going to overweight the most expensive and therefore the largest stocks.  In most Smart Beta approaches you are going to tilt more towards value and smaller stocks, this is most likely where the outperformance comes from.

For example, we use the Guggenheim Equally Weighted S&P 500 (RSP) ETF a lot in our strategies. Like the name suggests it equally weights all the companies in the S&P 500.   According to Morningstar over the past 10 years (as of 3/13/15) RSP has an average annual return of 9.13% vs. a return of 7.76% for the S&P 500.  Also according to Morningstar, the average market cap of the portfolio is $21.9 billion vs. $73.4 billion for the market cap weighted S&P 500.  So where did the outperformance come from?  It could be a random anomaly that was curve fit, but most likely it is the size tilt towards smaller cap stocks.

Will Smart Beta outperformance persist?  Who knows.  However, it makes sense that value---buying something for a low price, and small stock outperformance should continue over time so any strategy that tilts towards those factors should be fine.

Thursday, March 12, 2015

Time To Think Globally?

As a tactical manager there is no reason why you need to invest globally.  The whole point of being tactical is making as much money as possible and avoiding the large loss.  If you can do that in US Stocks then why bother complicating things?  However, if in the future there will be more opportunity in the making as much money as possible part internationally then I can't ignore that.  Below is a chart of the current CAPE ratios of markets around the world.  The US currently has the highest valuation.  The CAPE is an awful timing tool as markets can stay over and undervalued for a long time.  Markets that are undervalued are also undervalued for a reason---Russia doesn't have a CAPE of 4.62 because investors haven't discovered it yet.  However, the price you buy things at matters, if you are buying a market at high prices then your future returns will probably be lower than markets you are buying at lower prices.   We are working on a global strategy that we might ultimately want to launch as a global alternative to TUTT.

As of Date Market Current CAPE Median CAPE
Dec-14 Russia 4.62 7.4
Dec-14 Brazil 9.13 16.4
Dec-14 Italy 9.22 22
Dec-14 Poland 10.38 14.6
Dec-14 Spain 11.59 15.6
Dec-14 Turkey 11.72 13.4
Dec-14 UK 12.04 14.7
Dec-14 South Korea 12.19 16.6
Dec-14 France 13.81 19.3
Dec-14 China 14.04 18.2
Dec-14 Australia 15.68 16.4
Dec-14 Germany 16.6 17.8
Dec-14 Hong Kong 17.84 18.1
Dec-14 Thailand 17.98 20.5
Dec-14 Malaysia 18.14 21.6
Dec-14 Canada 18.79 19.1
Dec-14 Taiwan 19.29 19
Dec-14 Sweden 19.62 20.5
Dec-14 India 19.75 23
Dec-14 Indonesia 20.33 24.2
Dec-14 South Africa 20.39 18.8
Dec-14 Mexico 21.11 23.7
Dec-14 Switzerland 22.87 19.5
Dec-14 Japan 24.89 38
Dec-14 US (Large) 27.1 15.9

Source:  Research Affiliates LLC

Tuesday, March 10, 2015

Dynamically Weighting Uncorrelated Investment Methodologies

In our Trend Aggregation approach we believe in using a number of different, uncorrelated methodologies together.  Some methodologies, like counter trend, perform better in a choppy market. Others, like momentum, perform best in a trending market.  The million dollar question that comes up when you use different methodologies that work best in different markets is how to weight them.  We have experimented with all sorts of risk parity approaches but nothing seems to add any value over and above equal weighting.  We have always been fascinated by the idea that perhaps a timing mechanism could be developed that would dynamically weight different methodologies based on the probability that they would outperform.

Value and momentum are two facts that have been proven in a number of studies to beat the market over time.  They also tend to be uncorrelated with each other so a portfolio that is split 50/50 between value and momentum strategies has crushed the S&P 500 over time.  Could you improve on a 50/50 split by timing when it is best to be in value and when it is best to be in momentum?  I think you can, but the guys over at Alpha Architect just published a study showing one approach----using valuation spreads----doesn't add any value.

 http://www.alphaarchitect.com/blog/2015/03/04/do-valuation-spreads-matter-for-market-timing/#.VP6_MfnF9hw

That doesn't mean that it can't be done, just that perhaps this is not the way to do it.  This is an area we will continue to do work on as I believe that finding a way to dynamically weight uncorrelated methodologies has the potential to add a ton of value.

Monday, March 9, 2015

Value Investing Works---So Why Don't Individual Investors Do It?

I once heard a quote that the stock market is the only store where when things go on sale people leave.  We are all value investors at heart, just look at stores on Black Friday.  There has also been tons of academic research that value investing beats the market handily over time and that investors who put money into a market when it is undervalued do well, while investors who put money into an overalued market do poorly.

So if it is that easy why doesn't everyone do this?  Two reasons---the media effect, and the watch your neighbor get rich effect.

Media Effect----Value investors often have to be patient, it can take time for investors to recognize value so it is typically a longer term approach.  Value will also often underperform during times of speculative excess.   Therefore, it is very hard to be a value investor when you constantly turn on the TV or open the paper and hear about new highs.

Watch Your Neighbor Get Rich Effect---Many people think losing money is the most difficult thing to stand in the market, its not.  The most difficult thing to do is watch somebody else make money while you are not.  There is always some hot stock or hot sector somewhere and we all know somebody who is making money investing in it.  The longer that goes on the more tempted you become to buy it, once you finally capitulate it is frequently right at the top.

These two effects turn investing into a short term proposal, where the most important thing is how much you are making every day, week, or month.  The problem with that thinking is that those gains are just on paper and you typically give them all back, and then some, when the market goes down.  It is extremely hard to do but you need to look at investing as a longer term proposal.

You can make value investing more palatable and profitable by combining it with momentum and tactical asset allocation.  People who buy when there is "blood in the streets" will almost always make more money over time.  However, psychologically this is the hardest thing to do and often times you will be catching a falling knife.  Using momentum with value can avoid value traps where you buy something after it has gone down a lot and it keeps falling.  Value strategies are also not immune to drawdowns during bear markets.  Adding a tactical overlay can help cut maximum drawdowns down to a reasonable level.

What is Going On With Dividend Paying Stocks

In an era of low interest rates the dividend stock trade is real interesting.  If you can get a higher yield on a good quality stock than you can on a 10 year Treasury Bond it almost seems like a no brainer.   We all know that the Fed will eventually start raising interest rates, we just don't know when and by how much.  We also all know that when they do that it will hurt the prices of bonds, but what about dividend stocks?  The past couple of jobs reports have stoked fears of an earlier than expected Fed tightening.  Around both of those reports we have seen dividend stocks sell off quite a bit.  Year to date they are not doing that well.  Below is the year to date return (as of 3/6/15) of a couple of popular dividend stock ETFs compared to the S&P 500:

iShares Select Dividend (DVY)  -2.72%
Schwab US Dividend Equity (SCHD) -.28%
Vanguard Dividend Appreciation (VIG) .14%
S&P 500 1.00%

So what does history tell us about dividend stocks during rising rate environments?  Not that much.  I found a research paper from O'Shaughnessy that looked at the performance of dividend paying stocks over every period of rising rates

http://www.osam.com/pdf/OSAM_research_GlobalDividends_Aug13.pdf

Overall they found that dividend stocks underperformed the market but the results were not that conclusive.  Even more interesting is that they found using a shareholder yield approach outperformed the market.  Shareholder yield is something we have been interested in for a while.  It looks at all the ways that companies return cash to shareholders---dividends, stock buybacks, and debt retirement.  We have just come out with a new tactical dividend stock strategy that uses shareholder yield as one of our metrics.

Tuesday, March 3, 2015

The Colossal Failure of Buy and Hold

15 years later the NASDAQ finally got back to 5000.  This proves once again that markets  have big drops but they always get back to where they started.  Buy and holders might be taking a victory lap over this but they would be missing the point.  Anyone who had money in the NASDAQ 15 years ago and didn't sell is back to where they were---their money is back but they will never actually recover because of the opportunity cost.

For example, lets say you have two investors, investor A and investor B.  Investor A put $1mm into a NASDAQ index fund at the top of the market.  Investor B put $1mm into some investment that averaged 5%/yr.

Today investor A has his money back, his account is worth approximately $1mm.  Investor B doubled his money, he has a little over $2mm.  If both investors are able to earn 5%/year over the next 15 years they will both double their account values.  Investor A will have $2mm 15 years from now and Investor B will have $4mm.   The longer out you go the bigger the gap.

The real problem with buy and hold is not that markets don't come back from losses, they do.  The problem is that investors can never get back the lost opportunity cost as the losses take so long to recover from.

Friday, February 27, 2015

What is the Best Approach to Tactical?

Tactical Asset Allocation (TAA) is not a one size fits all, there are a lot of ways to implement a tactical strategy----relative strength, momentum, trend following, sector rotation, fundamentals, valuation, etc.   Practitioners of TAA will often argue that their way is better than others for whatever reason.  In 2014 many tactical managers struggled, particularly those who use any type of momentum analysis.  The reason was simple----even though the market closed up there was no momentum.  Does that invalidate decades of research proving that momentum works over every time frame and across assets classes?  Of course not.  Every investing approach cycles in and out of favor and every approach has it's kryptonite--- for momentum that is a choppy market.  Fundamental TAA strategies tend to be much slower to react so they would have done better last year.  Does that make them superior to momentum?  Of course not.  Fundamental TAA strategies just have different kryptonite.  Fundamentals often lag, meaning the market looks forward and predicts slower fundamental statistics before they happen.  Also, as John Maynard Keynes once said "Markets can remain irrational longer than you can remain solvent".

If different types of TAA strategies do well and do poorly in different markets that brings up an interesting idea----instead of trying to figure out what type of TAA methodology is best, investors should just combine multiple, uncorrelated methodologies.

Momentum should do well in a straight up or down market, but it should struggle in a choppy market and around equity peaks.  Momentum strategies typically would also not be able to participate in bear market rallies.  Counter trend strategies (buy into weakness and sell into strength) will tend to do well in choppy markets and around equity peaks but will lag in a straight up or down market.  Counter trend strategies can typically take advantage of of bear market rallies.  Fundamental strategies will typically do well in straight up or down markets but will be slower to react to a rally or a selloff.  Either type of strategy on its own would be powerful and should blow away buy and hold and MPT over time.  Combined they are much more powerful.

So which approach to tactical is best?  A combination of multiple, uncorrelated approaches.

Tuesday, February 24, 2015

Smart Beta Starting to Extend to Bonds

BlackRock is launching a new ETF on Thursday that is sort of a smart beta approach to bonds.  The ETF will use a mathematical model to try to have equal exposure to interest rate and credit risk.  You could argue that this is technically not smart beta depending on your definition, but this could be the start of new ETFs focused on the fixed income, especially as investors expect rates to rise which would hurt plain vanilla bond ETFs.  Like everything there are going to be some good and bad products launched.  We will need to do some more research on this strategy to see if we want to add this to our models.  On the surface I am not sure I like it that much, being tactical I would rather see  a product that shifted exposure from credit to interest rate risk tactically.  

We are also expecting to launch our own income ETF in the next couple of months.

Saturday, February 21, 2015

How To Top Money Market Yields

I have seen a bunch of stories in the media this week (I was quoted in a couple) talking about how investors should deal with low money market yields.  The advice was as to be expected----go into ultra short term bond funds and/or ETFs.  These funds typically yield under one percent, but that is better than zero, isn't it?  Maybe or maybe not.  First off you need to understand what money market funds are for, typically this is either:

1. Cash that you  might need very soon
2. Money that is allocated to cash tactically and could be re positioned any time to stocks or bonds
3. A small amount of cash to facilitate transactions, basically making sure you don't accidentally overbuy something.

In all of these cases you need easy and free access to your cash.  Ultra short term bond funds typically have restrictions on how often you can go in or out and ultra short term ETFs will typically have trading commissions, making neither choice a good substitute for cash.

We make use of ultra short term ETFs in our ETFs, primarily because we use cash tactically and we can buy and sell at institutional commission rates which are insignificant.  However, for individual investors these types of funds are typically a poor choice as they are not a substitute for what cash is used for and the yields, while better than zero, are still ridiculous.

Wednesday, February 18, 2015

Tactical Asset Allocation And a Positive Investor Experience



When doing any type of analysis it is always easier if your variables are static.  However, in real life most things are rarely static.  Take traditional risk tolerance and suitability for example.   In a buy and hold, asset allocation world a client would walk into an adviser's office and complete some sort of risk tolerance questionnaire that would place them in either a conservative, moderate, or aggressive category.  The adviser would then construct a portfolio based on the client's risk tolerance.  So for example, a client with a moderate risk tolerance might have a portfolio that is 60% stocks and 40% bonds.  In an up market they would get about 60% of the upside of the market and in a down market they would get about 60% of the downside.   If the investor was moderate all the time then this would probably work out ok, they would be satisfied with 60% market upside and would be ok with 60% market downside.  However, in real life risk tolerance is not static.  Investors by and large want relative returns in an up market and absolute returns in a down market.  Or said another way, in an up market an investor's benchmark is the S&P 500 and in a down market it is T Bills.  This moderate investor would be calling their adviser during a bull market looking for more exposure to gains and during a bear market looking for less exposure to losses.   Buy and hold has no answer to this except to tell the investor during the bull market that they can't have the gains and to tell them during the bear market that they have to have the losses.  This results in a poor investor experience.

Investor Experience

Advisers should strive to create the best possible investor experience for clients.  Investor experience encompasses risk tolerance, but it goes beyond that.  It is giving the investor the most return possible as an end result and making sure that they can tolerate the ride.  Too much risk and they will panic at some point.  Too little return and they will not be happy.  Because your moderate client is really looking for relative returns in an up market and absolute returns in a down market they will eventually have a poor investor experience, either by not making enough in an up market or losing too much in a down market.  

Tactical Asset Allocation as the Solution

Not only does your client's risk tolerance shift with the market, it should.  An aggressive investor shouldn't be aggressive during a 2008 type of market and a conservative investor shouldn't be conservative during a 2013 type of market.  In 2008 there was a ton of potential risk and not much potential return in the market.  In 2013 there was a ton of potential return and not much potential risk.  Tactical asset allocation (TAA) can be perfect for optimizing the investor experience by shifting allocations based on the risk and return in the market.  In an up market an investor who is moderate in the base case might move to moderate aggressive.  In a down market that same investor might move to moderate conservative or conservative.  TAA would be shifting the portfolio at the same time the investor's risk tolerance was shifting.  

Looking at investor experience, the more conservative investor judges investor experience by looking at volatility and drawdown first and return second.  The aggressive investors judges investor experience by looking at returns first and drawdown and volatility second.  Tactical asset allocation can provide drawdowns and volatility that would be acceptable for more conservative investors while providing return potential that would be acceptable for more aggressive investors.  

Tuesday, February 17, 2015

Why the S&P 500 Could Hit 2000

I was on CNBC last week talking about the possibility of the S&P 500 hitting 2000 over the next two weeks.

Pro: S&P at 2000

I got a little pushback even though a move to 2000 would only be about 4.6%.  Nobody can predict markets but they tend to move in predictable cycles.  Below is a chart of the S&P 500.  What is interesting as that four times since December the S&P has gone down to the 2000 level and bounced back.  You can also see a lot of support for the 2000ish level from September and October.


The S&P could very well rally here and never look back, but with turmoil still in Greece and Ukraine and uncertainty about what the Fed is doing, a move back to 2000 wouldn't be that strange.