Getting Started With Tactical Asset Allocation
Portfolio management strategies help investors navigate the complexities of the market and provide valuable structure and guidelines that promote higher returns. One proactive strategy to consider is tactical asset allocation. This approach involves an adjustment of the asset classes in a portfolio to consider the short-term conditions of the market.
Tactical asset allocation can improve returns over time. Should you consider tactical asset allocation? What are the benefits of this system? How easy is tactical asset allocation to manage?
Here we explore tactical asset allocation as a proactive strategy for higher returns and more efficient market management.
What Does it Mean?
Many investors, particularly those starting out, use the Efficient Market Hypothesis to justify their traditional investment strategy that involves a diversified portfolio which remains stable over the long term. The Efficient Market Hypothesis states that the market in the long term is relatively stable.
However, the absolutely efficient market does not necessarily exist. There are known anomalies in every market, and the correlation between different asset classes can never be stable. Tactical asset allocation is a means of taking advantage of these instabilities by switching the emphasis from traditional buy-and-hold investment to a more active approach.
Momentum and the Active Portfolio
Dual Momentum investing is one key factor of strategic asset allocation. The premier anomaly of the marketplace is momentum, and there can be a slight edge when using assets on the basis of their historical momentum as well as their performance compared to other assets. This strategy also exploits short-term mean-reversion to operate efficiently in volatile markets.
It can lead to buying and selling assets within a short time frame, typically a few days as part of an optimal momentum approach.
Sector rotation also helps improve an actively managed portfolio. Switching from one sector to another at the correct time helps to improve profits.
Exploring the Benefits of Tactical Asset Allocation
This active portfolio management technique benefits investors in many ways. There is more to investing than the traditional buy-and-hold approach. The passive investment state does not always produce valuable returns. A more active approach such as tactical asset allocation helps to maximise profits.
Plus, this strategy works in the face of recessions that inevitably strike an investor’s portfolio. Since recession is proven to regularly occur, and since it can generate losses up to 30 percent of an investor’s capital, actively managing a portfolio can increase the risk-adjusted return. You will be able to reduce the amount of money you need to set aside for your downturn fund.
Disadvantages of Tactical Asset Allocation
Be wary of diving straight into an active portfolio management strategy. It is not the ideal way to start off with investing, as it requires expert input. It can be time-consuming to manage your portfolio this way and may not suit the investor that likes to see a minimal input over a longer time period. There are also tax implications to consider.
Your attitude and aversion to risk also plays a part in how much you enjoy investing with this type of portfolio management technique. Losses can be painful to bear, but are often necessary in the long term. Tactical asset allocation can bring down the volatility that produces losses, but it may not be as “exciting”, therefore, for investors that prefer a more immediate response.
Tactical asset allocation is an effective and modern approach to diversification in a portfolio. It combines diversification across assets as well as across strategies. Different approaches can be applied simultaneously. For example, the combination of mean-reversion and momentum strategies leads to higher returns in different kinds of markets.