Tactical asset allocation might become your new normal

October 17, 2011

Market volatility is like a headache that hangs on. The cure may lie in shifting your mind from keenly focusing on risk instead of returns.

For many, this is an obvious no brainer, but it involves much more than simply shifting into cash, bonds or gold. What if you don’t want to exit stocks entirely? Then you may need what money managers call tactical asset allocation.

Instead of a long-only, hold-on-for-dear life approach of traditional investing, tactical planning involves shifting in and out of assets as market conditions dictate. In a turbulent market, there are several asset classes that can buffer stock downturns that can be found in several off-the-shelf mutual funds.

The linchpin of tactical investing is flexibility. It’s the opposite of the 60-percent stocks, 40-percent bonds fixed template. As a dynamic model, tactical portfolios are often open to moving into non-financial assets such as gold, real estate and commodities.

What I like best about tactical allocation is that it doesn’t go whole hog on any one asset class. Instead of loading up in the usual suspects in a bearish stock market — such as U.S. Treasuries or gold — it’s open to opportunities around the world. This can avoid big timing blunders and the prospect of being stuck in the wrong asset when markets turn.

It may be a while before the stock market turns bullish again when it’s being pulled in a number of negative directions. European debt woes, a sluggish U.S. economy and the prospect of a global recession are a menacing “lethal trifecta,” as Mohamed El-Erian, Chief Executive of PIMCO, noted recently.

“I worry that, absent a dramatic change in policies in America and Europe,” El-Erian wrote, “things will get worse before they get better. I fear that, given this possibility, it would then take years, if not decades, to repair the underlying damage done to economies, jobs and people’s lives around the globe.”

El-Erian’s “new normal” environment is not a happy place for stock investors, who may not see 1990s-level returns anytime soon. Although he didn’t specifically mention it, a tactical approach may be one way to battle a relentless onslaught of bad news.

Although far from a perfect solution — there is still significant market risk involved — tactical investing is but one way of addressing the worldwide malaise. Also called “global asset allocation,” it puts more arrows in your quiver and more professionals behind the decisions of how best to reduce risk.

Take PIMCO’s Global Multi-Asset Allocation fund, for example. As a “fund of funds,” it invests in mostly PIMCO funds plus the Vanguard Emerging Markets exchange-traded fund, an index of stocks from developing countries.

Slightly more than one-quarter of the PIMCO fund is invested in U.S. stocks, with 60 percent in bonds from across the world and a touch (about 3 percent) in the SPDR Gold Trust ETF, which holds bullion.

Like most fund of funds, though, the PIMCO fund is expensive to hold, charging a minimum 1.14 percent annually for expenses. It also turns over its portfolio at a 70-percent rate, which generates additional transaction costs.

Of course, you could also assemble a tactical portfolio on your own by employing ETFs. I would consider this approach only if you have the time to do the research on global macroeconomic trends and feel confident using multiple asset classes and know how they move relative to each other. It’s far too easy to get the mix wrong; it consistently baffles most market watchers.

Yet another alternative is to use a portfolio already created and risk-rated by services such as MyPlanIQ. Private money managers, registered investment advisers and certified financial planners can also provide this service, but will charge you around 1 percent annually of your assets under management.

Whichever approach you choose, pick a strategy that best suits your ability to stomach risk. If you can’t afford to suffer loss of principal, you’re better off in U.S. Treasury bonds (that you hold to maturity), cash and inflation-protected securities. Better to watch other people get headaches than to needlessly bring on a migraine yourself.

(This analysis is corrected to delete material in the 4th paragraph from the bottom to reflect that Vanguard Asset Allocation fund is no longer available.)




We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Yikes! Shifting in and out IS market timing at best or gambling at worst.

I’ll give you credit though for stating that tactical allocation is “far from a perfect solution”.

I have a better idea. Why not call your congressman or senator and suggest a slight transaction tax to flush out the high frequency traders. Until equity markets become a place for legitimate businesses to raise capital in a transparent way I’ll stay on the sidelines, because I can afford to.


Posted by Missinginaction | Report as abusive

Excellent article explaining the numerous benefits of tactical asset allocation. When correctly implemented, these strategies can provide a significant boost to a portfolio’s returns with limited risk. There are several resources on the web that provide evidence of the power of global tactical asset allocation based on relative strength for example. See details at My ETF Hedge Fund website: http://myetfhedgefund.com

Posted by JayPoupsaldi | Report as abusive