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.

No comments:

Post a Comment