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 6 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 7 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 9 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 10 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 17 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 18 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 25 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 26 Questions? Tactical Asset Allocation: History, Theory and Practice Brian Schreiner Schreiner Capital Management, Inc. Exton, PA 610-524-7310 bschreiner@scminvest.com 27 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. 28