Tactical Asset Allocation
in Bull/Bear Markets
Timothy J. Marchesi, CFA
President, CEO & Co-CIO
DeMarche Associates, Inc.
DeMarche
Associates, Inc.
Agenda
•
Importance of Asset Allocation
•
Tactical vs. Conventional Approach
•
Economic & Market Environment
•
Supercycles
•
Dynamic Investment Strategies
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Importance of Asset Allocation
•
Studies estimate that asset allocation decision
accounts for 91.5% of the variation between
returns of different funds 1
•
Asset mix optimization models mathematically
seek maximum expected rate of return for a given
level of risk (or minimization of risk for a given
expected return) 2
1
Financial Analysts Journal, May/June 1991 – Brinson, Singer & Beebower
2
Global Asset Allocation Techniques for Optimizing Portfolio Management, 1994 – Lummer &
Riepe
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Review of Conventional Approach
•
•
•
Inputs based upon history
Typical models assume “average” future outcomes
Often ignore starting /ending market levels
Large Capitalization Stocks
Distribution of Returns
Quarterly One-Year Returns
1926-2009
40
35
30
25
Number of
Occurrences
20
15
10
5
0
-50 -45 -40 -35 -30 -25 -20 -15 -10 -5
0
5
10
15
20
25
30
35
40
45
50
Percent Return
Source: S&P 500 Index
Some returns are greater than 50% and less than -50%
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Review of Conventional Approach
• Typical models assume “average” future outcomes
(sample chart below)
12%
Emerging Equities
10%
Small Cap Equities
Large Cap Equities
8%
Hedge Fds
Bonds
6%
4%
2%
Today
2015
2020
5
2025
2030
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One-Year Returns Are Volatile
Models incorporate standard deviation to manage risk
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Model Optimization:
The Efficient Frontier
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What is Tactical?
Webster’s:
•
“Small-scale action to serving a larger purpose”
In Investment Management:
•
Method of modifying asset allocation based upon
valuation estimates and judgments of the future
return of markets or sectors
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Time Horizon for Investment Objectives
Asset Allocation Study has both a strategic perspective and
a long-term secular perspective
Investment Horizon
Short
Term
Market
Timing
One Year
Or Less
Long
Term
Tactical
Asset
Allocation
Strategic
Asset
Allocation
Several Market
Phase Cycles
Current Market
Phase Cycle
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Secular
Asset
Allocation
Multiple Market
Supercycles
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DeMarche Market Phases
A typical market cycle has four distinct phases:
Tactical Market Phase
Stock
Prices
Corporate
Earnings
Total
Return*
Phase I – Early Bull


62.0%
Phase II – Bull Market


20.8%
Phase III – Late Bull/Early Bear


0.5%
Phase IV – Bear Market


-27.0%
*Annualized cumulative returns of S&P 500 Index. Study based upon monthly data from 1/31/639/30/11. The annualized cumulative return for the full study period was +9.5%.
Source: DeMarche Research
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Markets Change
Markets change over long periods of time
•
As markets change, relative value between asset
classes changes
•
DeMarche research has acknowledged and
identified these long wave markets as
“Supercycles”
•
Multiple bull and bear markets exist within each
“Supercycle”
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DeMarche Supercycle Study
Years
Bank Panics/
Recessions
Market Cycles
(Bull/Bear Cycles)
A. High Growth
1900 – 1929
8
8
B. Moderate Growth
1929 – 1942
3
5
C. High Growth
1942 – 1966
5
8
D. Moderate Growth
1966 – 1980
3
6
E. High Growth
1980 – 2000
2
5
2000 - Present
2
3
Supercycle
F. Moderate Growth
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DeMarche Supercycle Study
Supercycle
Beginning
End
DJIA Price Return*
A
1900
1929
+882%
B
1929
1942
-75
C
1942
1966
+701
D
1966
1980
+2
E
1980
2000
+1,444
F
2000
Present*
-5
*As of 3/31/2011. Cumulative returns are shown for each cycle (non-annualized).
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The Consumer in Supercycles
Supercycles
Environment
A
1900 – 1929
High population growth
B
1929 – 1942
High unemployment
C
1942 – 1966
Baby boom / income growth
D
1966 – 1980
Inflation
E
1980 – 2000
Expansion of consumer credit
F
2000 – ?
Demographics & debt
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New Normal
Macroeconomic Environment
•
Demographics

•
“Boomers” retire or shift emphasis from consumption
to saving
Consumers gradually improve their finances

Paying down debt / increase savings
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New Normal Macroeconomic
Environment (cont’d)
• Unemployment
• Wage growth remains slow
• Less help from asset gains (wealth effect)
• Higher taxes
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Strategic Implications of
Current Supercycles
•
Stock returns likely to underperform mean
•
Bond returns likely to underperform mean
•
Policies need other strategies to improve expected
risk/return outcomes
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Asset Allocation – Expected Returns
Next 5 Year “Strategic” Period versus Long-Term “Secular” Time Horizon
Source: DeMarche Associates. See notes on next slide.
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Asset Allocation – Expected Returns (cont.)
•
Notes for chart on prior page:
•
Represents geometric return estimates for the 5 years
beginning January 2012, compared to long-term average
geometric returns over multiple Supercycles (no specific
beginning point). 5-year horizon utilizes an assumption of a
moderate economic growth environment within the current
Supercycle, as defined by DeMarche.
U.S. Fixed Income has poor E.R. over the strategic period.
Such assets presently have very low current income yield
and are at risk of principal value losses as interest rates rise.
Other asset classes are shown for comparison.
•
•
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Dynamic Investment Strategies
•
•
•
•
Hedge Funds
Global Tactical Asset Allocation (GTAA) Funds
Lifecycle or Target Date Fund (TDFs)
Intro to some assets used by dynamic strategies



Commodities
High Yield Bonds
Emerging Market Bonds
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Brief Intro to Hedge Funds
and GTAA Strategies
•
Different HF Fund of Funds approaches for clients


•
•
•
•
•
Conservative – emphasis on diversification, lower
volatility
Strategic – more use of directional market bets,
leverage
GTAA is long-only, relative valuation-based
Fees higher with HF
Limited transparency with HF
GTAA correlation is high (vs. stocks/bonds)
Wide variance across manager/strategies
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Sample Range of GTAA Fund Approaches
Classic
More Complex
Comprehensive
Cash
X
X
X
Domestic Equity
X
X
X
International Equity
X
X
Emerging Markets Equity
X
X
X
X
International Bonds
X
X
Emerging Markets Bonds
X
X
Asset Classes Used
Domestic Bonds
X
High Yield Bonds
X
Inflation Protected (TIPS)
X
Convertibles
X
X
Commodities
X
X
Real Estate (REITs)
X
Listed Private Equity
X
Currency
X
X
X
X
X
X
Typical Investments
Mutual Funds
X
Closed-End Funds
Exchange-Traded (ETFs)
X
X
X
Individual Securities
X
X
X
X
X
Derivatives
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What is a Target-Date Fund?
• Description of TDF (or Lifecycle Fund):

Diversified investment option

Target a specific retirement year (2020, 2030, etc.)

Professionally managed

–
Stock allocation reduced as retirement year nears
–
Disciplined rebalancing of underlying funds
May use less-traditional investments
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Example of TDF Asset Allocation
Fewer equities as participant retire date nears
Source: PIMCO, compiled by MarketGlide.
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TDF Glidepaths
Programs reduce equities over time; some have tactical range
Glidepath
Active Average vs Passive Average
100
Percentage Equity Allocation
80
Passive
Manager
Average
60
Active
Manager
Average
40
Industry
Max
Industry
Min
20
0
2055
2050
2045
2040
2035
2030
2025
25
2020
2015
2010
2005
2000
1995
DeMarche
Associates, Inc.
Brief Intro: Commodities
•
•
Energy, Metals, Agriculture, Livestock
Weights differ among several indexes

•
Portfolio diversifier


•
•
S&P has 65-75% Energy: others cap at 33%
Hedge against unexpected inflation
Slight negative correlation to stocks & bonds in past
Liquidity varies; fund choices very distinct
Key concerns: China, oil, gold
Total return from commodities comes from combination of: rolling futures contracts (roll yield), yield from the cash collateral, and the spot price gain or
loss. Derivatives use is widespread (active or passive).
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Brief Intro: High Yield & Emerging Market Bonds
•
•
Both have low correlations to U.S. Bonds
U.S. High Yield Bonds





•
Quality ratings of “BB” or lower (below investment grade)
Average maturities 3-10 years
High level of current income payments
Default risk rises in recessionary periods
Higher volatility and potential losses than other fixed income
Emerging Market Bonds are investment grade





Obligations of foreign government or corporation
Average maturities 3-10 years
Higher fees (management, transaction, custodial)
Political, liquidity, and other risks differ from U.S. bonds
Currency risk (some issued in U.S. dollars)
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Recommendations
•
•
•
•
•
Adjust asset allocation more frequently
Incorporate Supercycles
Emphasize liquidity
Diversify
Increase allocation to dynamic strategies
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Questions?
Thank you!
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