Tactical Asset Allocation:
History, Theory & Practice
Brian Schreiner
Schreiner Capital Management, Inc.
Exton, PA - www.scminvest.com
June 26, 2014
Introduction
Two Types of Investment Strategies:
› Passive Investing
or… Buy-and-Hold
or… Strategic Asset Allocation
› Active Investing
or… Tactical Asset Allocation
2
Agenda
› Background
- What is Tactical Asset Allocation (TAA)?
- How is TAA different from Strategic Asset Allocation (SAA)?
› History
- TAA from the Old Testament to Today
- The evolution of TAA
› Theory
- Why has TAA become more popular in recent decades?
- What are the potential benefits and risks of TAA?
› Practice
- What are the different approaches, objectives and benchmarks?
- Focus on trend following
› Q&A
3
Background
› Definitions | What is TAA?
“Tactical asset allocation (TAA) broadly refers to active strategies which seek to
enhance performance by opportunistically shifting the asset mix of a portfolio in
response to the changing patterns of reward available in the capital markets.”
- Arnott & Fabozzi, Asset Allocation: A Handbook of Portfolio Policies, Strategies &
Tactics, 1998
“Tactical asset allocation (TAA) actively adjusts a portfolio’s strategic asset
allocation (SAA) based on short-term market forecasts [or trends]. Its objective is
to systematically exploit inefficiencies or temporary imbalances in equilibrium
values among different asset or sub-asset classes.”
- Vanguard Research, 2010:
4
Background
› How is Tactical Asset Allocation (TAA) different from
Strategic Asset Allocation (SAA)?
5
History
In the beginning…there were “Speculators”
1011 BC
Diversification: King Solomon
FAST FORWARD 2,645 Years…
1634-1637
Market Trends: Tulip Mania in Holland
1890s
Professional Money Management: The Robber Barons
1899-1902
Trend Following: Charles H. Dow
1934
Value Investing: Benjamin Graham “Security Analysis”
1930s, 40s, 50s
…and beyond: Published works on many types of investing
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History
1976
Tactical Asset Allocation: William Fouse of Wells Fargo
1980
The Information Age begins: Business Computers & PCs
1981
US stocks decline 27%
1987
Global stock markets crash
1991
The Internet: A Global Network (data as we know it)
1990s
Greatest bull market in US history - TAA underperforms
2000
Tech Bubble peak (March 10)
2007-08
Financial Crisis
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Theory
› Why use TAA?
1. Return expectations from stocks and bonds are very low over next decade.
- Investors are seeking more attractive returns.
2. Stock and bonds are expensive - priced near all-time highs.
- Investors want to limit exposure to risky assets.
3. Volatility has been low and will likely increase.
- SAA is highly volatile - investors can reduce volatility through TAA
8
Theory
› Who is using TAA?
Everyone…
-
Institutions
Endowments
Pension Funds
Professionals/Family Offices
Individual Investors
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Theory
› Percentage of RIAs who describe their overall investment approach as:
2007
2009
2011
2013
Strategic
50%
48%
65%
65%
Tactical
35%
39%
27%
22%
Other
15%
19%
8%
13%
Source: AdvisorBenchmarking.com 2013
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Theory
11
Theory: Return Expectations are Very Low
Expected return from a 60/40
stock/bond portfolio is 2.3%
over the next decade.
12
Theory: Stocks & Bonds Near All-Time Highs
STOCKS
BONDS
13
Theory: Stock Market Volatility May Rise
CBOE Volatility Index (VIX)
14
Theory: Stocks are Expensive by Historical Standards
15
Theory: Opportunities Exist for Active Investors
Source: CrestmontResearch.com
16
Theory: Opportunities Exist for Active Investors
50%
45%
41%
38%
40%
40%
36%
30%
33%
32%
29%
30%
27%
25%
23%
20%
17%
16%
12%
10%
10%
13%
9%
0%
0%
-3%
3%
3% 4%
2%
0%0%
-1%
-3%
-1%
-10%
-16%
-22%
-30%
-2%
-4%
-11%
-13%
-15%
-16%
-20%
-2%
6%
6%
4%
-1%
-3%
-6% -6%
-2%
-6%
-7%
0%
0% 0%
-2%
-4%
-5%
-6%
-9%
-10%
-11%
-17%
-19%
9%
5%
5%
3%
0%
-2%
-3%
-2%
13%
11%
9%
-9%
-13%
-15%
5%
3%
3%
0%
-5%
-5%
-10%
17%
15%
15%
14%
-1%
0%
-1%
-1%
-3%
-4%
20%
8%
2%
1%
1%
25%
18%
17%
10%
5%
0%
21%
21%
17%
15%
26%
24%
23%
22%
19%
30%
28%
27%
-15%
-15%
-17%
-23%
-25%
-28%
-26%
-28%
-33%
-38%
-40%
-50%
-50%
1950 52
54
56
58
60
62
64
66
68
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98 2000 02
04
06
08
10 2012
Source: Schreiner Capital Management, Inc. & Yahoo! Finance
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Practice
› Benchmark:
TAA strategies are usually measured against
a passive benchmark.
› Objective:
Better-than-benchmark returns and/or
Less-than-benchmark risk
› Approach:
1. Subjective
2. Quantitative
3. Combination of the two
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Practice
› Commonly Used Quantitative TAA Strategies
1. The Fed Model Signals (Fundamental)
Compares stock earning yields to bond yields to determine relative strength
2. Macroeconomic or Business-Cycle Signals (Fundamental)
Measures variations in market risk premiums and firms’ earnings
3. Fundamental Valuation Signals (Fundamental)
Bottom-up (firm-valuation based on dividend yield, book/market ratio, PE ratio)
and/or Top-down (dividend discount model) valuation metrics.
4. Trend Following Signals (Technical)
Technical analysis of market data (mostly price) to identify momentum
5. Sentiment (Technical)
A contrarian approach that looks for signs of extremes (ie: consumer/investor
confidence, margin borrowing)
19
Practice
› Primary Types of Trend Following:
1. Trend Line Analysis /Charting
2. Moving Average Systems
3. Relative Strength Indicators
20
Practice
› Trend Following Using Trend Line Analysis/Charting
Support
Resistance
Channels
Bands
Flags
Candlesticks
Rates of Change
Oscillators
Clouds
Heads
Shoulders
…it’s endless
21
Practice
› Trend Following Using Moving Average Systems
Source: Schreiner Capital Management, Inc. For financial professional use only.
This is a hypothetical example for illustration purposes only.
22
Practice
› Trend Following Using Relative Strength Indicators
Relative Strength indicators measures the change and direction
of price movements.
Relative Strength =
% change Industry Sector Fund
÷
% change in Benchmark
23
1
7
13
19
25
31
37
43
49
55
61
67
73
79
85
91
97
103
109
115
121
127
133
139
145
151
157
163
169
175
181
187
193
199
205
211
217
223
229
235
241
Practice
› Trend Following Using Relative Strength Indicators
45.00
40.00
35.00
30.00
25.00
20.00
24
1
7
13
19
25
31
37
43
49
55
61
67
73
79
85
91
97
103
109
115
121
127
133
139
145
151
157
163
169
175
181
187
193
199
205
211
217
223
229
235
241
Practice
› Trend Following Using Relative Strength Indicators
0.85
0.80
0.75
0.70
0.65
0.60
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Practice
› Primary Considerations for Investors
Investment Profile
- Investment Personality
- Investment Goals
- Portfolio Profile
- Risk Tolerance
- Time Horizon
Due Diligence
- Investment Manager(s)
- Investment Vehicle
- Investment Philosophy
- Investment Process
Implementation
- Execution Costs/Fees
- Tax Implications
- Opportunity Costs
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Questions?
Tactical Asset Allocation: History, Theory and Practice
Brian Schreiner
Schreiner Capital Management, Inc.
Exton, PA
610-524-7310
bschreiner@scminvest.com
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Sources
Arnott, Robert and Fabozzi. Asset Allocation: A Handbook of Portfolio Policies, Strategies & Tactics. Probus
Publishing Co., 1998.
Faber, Mebane T. “A Quantitative Approach to Tactical Asset Allocation.” The Journal of Wealth Management. Spring
2007. Working Paper, Updated February 2009. Electronic copy available at: http://ssrn.com/abstract=962461.
Ivanova, Maya. AdvisorBenchmarking Annual Research Study. AdvisorBenchmarking.com. 2008-10.
Loeb, Gerald M. The Battle for Investment Survival. New York: John Wiley & Sons, Inc., 1935.
MacKay, Charles LL.D. Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. Mansfield Centre,
CT: Martino Publishing, 2009. (First published: 1852)
Mallik, Gaurav. “Mitigating Equity Market Correlations Through Stock Selection.” SSgA Capital Insights. August,
2009.
Ostgaard, Stig. “On the Nature and Origins of Trend-Following.” December, 2008. www.lastatlantis.com.
Stockton, Kimberly A. and Shtekham, Anatoly. “A Primer on Tactical Asset Allocation Strategy Evaluation.” Vanguard
Research. 2010.
Shiller, Robert J. Irrational Exuberance. Second Edition. Princeton University Press: 2005.
www.irrationalexuberance.com
Wai, Lee. “Advanced Theory and Methodology of Tactical Asset Allocation.” Duke University. January 2000.
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