Tactical asset allocation
Encyclopedia
Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a portfolio’s asset allocation
. The goal of a TAA strategy is to improve the risk-adjusted returns of passive management
investing. TAA strategies can be either discretionary or systematic.
In discretionary tactical asset allocation strategies, an investor modifies his asset allocation according to the valuation of the markets, in which they are invested. Thus, someone invested heavily in stock
s might reduce their position when they perceive that other securities, such as bond
s, are poised to outperform stocks. Unlike stock picking, in which the investor predicts which individual stocks will perform well, tactical asset allocation involves only judgments of the future return of complete markets or sectors. As such, some practitioners perceive it as a natural supplement to mutual fund
investing, including passive management
investing.
Systematic tactical asset allocation strategies use a quantitative investment model to systematically exploit inefficiencies
or temporary imbalances in equilibrium values among different asset classes. They are often based on known financial market anomalies (inefficiencies) that are supported by academic and practitioner research. For example, many systematic TAA strategies use quantitative Trend Following
or Relative Strength
techniques to produce excess investment returns. These both aim to capitalize on Momentum
, a well-known market anomaly.
Many factors determine the success of a TAA strategy. The investor needs to have the necessary knowledge, practical investment skills, dedication, and discipline to design and/or execute a successful tactical strategy. The specific market anomalies on which the strategy is based may change or disappear in the future. Other factors such as risk tolerance, market timing
, portfolio size, investment expenses, etc. may also affect the portfolio performance.
Asset allocation
Asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.-Description:...
. The goal of a TAA strategy is to improve the risk-adjusted returns of passive management
Passive management
Passive management is a financial strategy in which an investor invests in accordance with a pre-determined strategy that doesn't entail any forecasting...
investing. TAA strategies can be either discretionary or systematic.
In discretionary tactical asset allocation strategies, an investor modifies his asset allocation according to the valuation of the markets, in which they are invested. Thus, someone invested heavily in stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s might reduce their position when they perceive that other securities, such as bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
s, are poised to outperform stocks. Unlike stock picking, in which the investor predicts which individual stocks will perform well, tactical asset allocation involves only judgments of the future return of complete markets or sectors. As such, some practitioners perceive it as a natural supplement to mutual fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
investing, including passive management
Passive management
Passive management is a financial strategy in which an investor invests in accordance with a pre-determined strategy that doesn't entail any forecasting...
investing.
Systematic tactical asset allocation strategies use a quantitative investment model to systematically exploit inefficiencies
Market anomaly
A market anomaly is a price and/or return distortion on a financial market that seems to contradict the efficient market hypothesis.The market anomaly usually relates to:...
or temporary imbalances in equilibrium values among different asset classes. They are often based on known financial market anomalies (inefficiencies) that are supported by academic and practitioner research. For example, many systematic TAA strategies use quantitative Trend Following
Trend following
Trend following is an investment strategy that tries to take advantage of long-term moves that seem to play out in various markets. The strategy aims to work on the market trend mechanism and take benefit from both sides of the market, enjoying the profits from the ups and downs of the stock or...
or Relative Strength
Relative strength
Relative strength is a ratio of a stock price to a market average. It is used in technical analysis.It is not to be confused with Relative Strength Index....
techniques to produce excess investment returns. These both aim to capitalize on Momentum
Momentum investing
Momentum investing, also sometimes known as "Fair Weather Investing", is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period...
, a well-known market anomaly.
Considerations
The efficient-market hypothesis would imply that tactical asset allocation cannot increase risk-adjusted returns, since markets are already efficiently priced. If a tactical approach were found that could increase returns without an increase in risk, investors would flock to that inefficiency, and the advantage would go away. Many investors do not accept this hypothesis, however, and believe that inefficiencies in the market persist and can be exploited.Many factors determine the success of a TAA strategy. The investor needs to have the necessary knowledge, practical investment skills, dedication, and discipline to design and/or execute a successful tactical strategy. The specific market anomalies on which the strategy is based may change or disappear in the future. Other factors such as risk tolerance, market timing
Market timing
Market timing is the strategy of making buy or sell decisions of financial assets by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis...
, portfolio size, investment expenses, etc. may also affect the portfolio performance.