What is the difference between Strategic Vs Tactical Asset Allocation? What does this difference mean for investors when it comes to asset allocation. Perhaps more importantly, what does this mean for your potential returns?
The terms strategic and tactical asset allocation are commonly used interchangeably. This causes confusion for do-it-yourself investors. These investment strategies are actually very different, and research shows that there are distinct outcomes from tactical vs strategic asset allocation.
Understanding your asset allocation strategy is critical when it comes to investing. Understanding the differences between these distinct asset allocation approaches is key to being confident with your investments. This can help you to avoid excessive fees and reduced returns.
Tactical Asset Allocation (TAA) also offers a potential way for investors to exploit the market. Which could potentially unlock hidden returns. This is because TAA funds can invest focus on areas of the market that have more optimal valuations or growth potential.
Disclaimer: This should not be considered financial advice and you are responsible for your own investment decisions. When investing capital is at risk.
What Is Asset Allocation Strategy?
Asset allocation is the process by which your investments are funnelled into various categories. The primary categories are stocks, bonds, and cash. Your personal asset allocation decision depends on your risk tolerance and time horizon. Younger, more risk tolerant investors tend to hold greater percentages of stock assets.
< Explore: < Explore: What are TIPS Bonds: How To Profit Against Inflation >
What is Strategic Asset Allocation?
The primary focus of strategic asset allocation is to construct an efficient portfolio. Which contains the optimal mix of asset classes based on your financial goals, risk tolerance and desired growth. This is a long-term solution to managing your investments in both a strategic and emotional way.
Advocates of strategic asset allocation argue that this strategic focus helps investors avoid making short-term, emotional decisions based on current market events. It helps investors avoid panic selling and the classic buying high and selling low behaviours.
The portfolio is continuously balanced to meet the investors needs. For example, an Investor may establish a strategic asset allocation target of 70% stocks and 30% fixed income. Following a strong year for the stock market, the allocation to stocks may have drifted up to 80%. The fund manager would then sell-down the stock allocation from 80% down to the strategic target of 70%. The sale proceeds would be used to buy more fixed income assets. Increasing the allocation back up to 30% of the portfolio.
Strategic asset allocation has proven to be an effective approach. Strategic asset allocation means buying stocks in periods of market stress. This means that investors can dollar-cost-average through volatile markets, which can translate into strong returns. The pitfall is that short-term thinking and emotions can derail the strategic asset allocation process. This only becomes an issue if the investor actively gets involved and sells-down their portfolio.
< Explore: The 4% Rule For Retirement Could Fail For The First Time >
What Is Tactical Asset Allocation?
Tactical asset allocation involves selectively adjusting the portfolios weighting based on short or medium market expectations. In short, the investor can change their asset allocation based on how the economic conditions, valuations and market cycles. For example, in the build up to the end of 2021 the fund manager may have been reduced their stocks in anticipation of a market crash.
In recent times a TAA fund manager may decide to reduce exposure to U.S. stocks and increase their weighting to international equities. Reducing this allocation to “below normal” levels may reduce exposure to overpriced assets in exchange for under-priced stocks and bonds. Many would argue that in recent times US equities have been over-priced and entering bubble territory. By contrast, Emerging market equities are nearing the end of their longest ever bear market. This means they could present favourable valuations and future returns.
Morgan Stanley argues that this multi-asset class strategy “presents opportunities to generate excess return due to structural inefficiencies such as home-country bias and the tendency for a majority of investors to focus on security selection”.
Blackrock also outlines that skilful investors can generate returns from Tactical Asset Allocation (TAA) by exploiting:
- Variation in rewards for bearing risk
- Market segmentation and structural impediments
- Information and processing asymmetries
- Non-alpha seeking market participants
- Behavioural biases
< Explore: 5 Minute Survival Guide To Investing With Index Funds >
What Is the Difference Between Strategic Vs TAA
Strategic and TAA strategies are comparable in that they are both multi-asset investment approach. Both use a portfolio via asset allocation based approach. This means they buy at the asset class, country, and/or sector level rather than through individual security selection.
So, what is the difference between Strategy vs Tactical Asset Allocation? Strategic asset allocation is to construct and maintain a portfolio with the optimal mix of different asset classes. A strategic asset allocation may contain a healthy mix of stocks, bonds and cash with the goal of maximising returns whilst minimising risk. This can be tailored to the investors risk tolerance and investment time-horizon.
By contrast, a TAA portfolio manager actively allocates across assets according to their assessment of opportunities and risks in the prevailing market environment. Fund managers have a mandate to continuously and dynamically shift positions across asset classes and instruments. This means that there can be a huge difference in the returns of a strategic vs tactical asset allocation.
Which Strategy Is The Offers The Best Returns?
The difference between strategic asset allocation and TAA is that the former maintains a pre-agreed asset allocation and the latter actively shifts to deliver attractive returns. A strategic asset allocation will involve sticking with your original allocation over long periods of time (e.g. a decade). Tactical asset allocation strategies a reactive to the constantly changing economic environment.
The difference between ‘strategic’ and ‘tactical’ asset allocation is therefore one of timing. As we know, trying to time the market can have disastrous consequences. In theory, these tactical allocation changes will result in superior returns compared to a strategic asset allocation approach.
Historically evidence is overwhelmingly against active fund management when it comes to equity-based index funds. When it comes to a balanced multi-asset investment profile (stocks, bonds etc), the jury is still out. It is yet to be concluded if Strategic Asset Allocation outperforms TAA.
Global Tactical Asset Allocation ETFs
To conclude, the Strategic Asset Allocation approach is a more fixed asset allocation with buy-and-hold approach. The tactical asset allocation approach has a mandate to divert assets to investments that offer higher potential returns. This is because they can exploit specific areas of the market that present a strategic opportunities.
The problem is that Tactical and Strategic funds are challenging to differentiate. This is partly because the devil is in the detail when it comes to understanding if active funds invest in individual stocks or a portfolio via asset allocation based approach. I have identified a number of strong performing Tactical multi-asset allocation funds. A number of these funds include actively managed allocation of investments into passively managed investment schemes and exchange traded funds.
8 Global Tactical Asset Allocation ETFs:
