Tactical Adjustments (EBI #4)

Tactical Adjustments (EBI #4)
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What are tactical adjustments? In their 1986 asset allocation research, Brinson, Beebower, & Hood defined tactical asset allocation as:

“…strategically altering the investment mix weights away from normal in an attempt to capture excess returns from short-term fluctuations in asset class prices (market timing);”

When it comes to tactical asset allocation, a growing body of evidence shows investors who make tactical moves in their portfolios do best when both technical analysis and fundamental analysis align.

Technical analysis essentially believes that by analyzing certain factors that impact the price of a security (not necessarily the underlying company or issuer), one can gain information that enhances returns. It’s important to note that technical analysis is not a good predictive tool. By its very nature of looking at past prices, technical analysis will lag market prices in either up or down directions.

One final note on technical analysis pertains to time horizon. Technical analysis serves to inform investors about what is currently happening, or what has happened based on the most recent prices in any given market. Therefore, its use has focused on the short-term.

Once a pattern (momentum, relative strength, etc.) can be determined, investors take action. For longer-term time horizons, a different approach to security selection – fundamental analysis – is more relevant.

Fundamental analysis is the process by which investors research an issuer to derive a security’s true intrinsic value, and then look for times when the market believes it to be more or less than this intrinsic value. Over time, prices and value will converge. Fundamental investors typically analyze equities, although the practice can be applied to other securities as well.

Again, the question of whether technical or fundamental analysis is preferred for asset allocation is moot; both should be employed in order to achieve optimum results.

In 1996, investor James O’Shaughnessey published What Works on Wall Street, in which he tested various metrics and strategies to see which approach to investing generated the best returns. His conclusion was that a combination of attractive value metrics coupled with good momentum and trends performed best over long periods of time. While there are time periods in which certain factors play larger roles, utilizing both fundamental and technical indicators produced the highest returns.

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In 2006, hedge fund manager and professor Joel Greenblatt published The Little Book That Beats the Market in which he shared his research and introduced what he called his “magic formula” for stock picking: Value plus Momentum as a superior approach. Greenblatt’s hedge fund, Gotham Capital, utilized his research to generate 40% annualized returns for its investors from 1985 to 2005.

Institutional research firm NDR Research combines fundamental and tactical inputs into their asset allocation recommendations. In the firm’s words, “fundamental analysis tells what should be happening, and technical analysis tells what is happening.” Since markets can remain over or undervalued for years at a time, technical indicators are critically important in determining a change in trend. Utilizing this approach has helped the firm generate tactical asset allocation recommendations that have resulted in an additional 2.5% of gains per year. (Source: “NDR Global Balanced Account Model: Monthly Data 1990-01-31 to 2014-05-3” Ned Davis Research, Inc. 2014)

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Tactical Adjustments within Asset Classes

Asset allocation should not be limited to the choosing among the major asset classes of stocks, bonds, or alternatives. In fact, the evidence is clear that allocating within asset classes has material impact on portfolio return.

For example, within the U.S. equity market, investors may allocate between stocks in various economic sectors depending upon the current economic cycle. The utilities sector (electric utilities, regulated gas companies, etc.) tends to have very steady streams of earnings, making them less vulnerable to the highs and lows of the economic cycle. Conversely, consumer discretionary stocks (i.e. retailers, auto dealers, restaurants) are businesses that people either forgo during recessions or frequent more often during economic booms. As such their earnings can swing more than the economic cycle itself. By allocating equities between defensive versus cyclical stocks, investors can further improve their results.

We can observe the resiliency of these defensive sectors during down markets. In studying monthly returns since 1990, defensive sectors outperformed the S&P 500 75% of the time when the S&P 500 declined. Conversely, during months when the S&P 500 rose, these defensive sectors lagged 63% of the time. This evidence clearly shows how successful tactical allocation within equities can enhance investment returns. (Janiczek & Company, Ltd. analysis of Bloomberg data, 2014)


The same concept of allocating within an asset class holds within bonds. As the economic cycle turns higher, bonds of lower quality outperform as investors assume their credit rating may improve. Further, as investors prefer stocks to bonds while monetary policy begins to worry about rising inflation, interest rates tend to increase during economic upturns. Therefore, investors generally prefer shorter-term bonds to longer-term bonds. In recessions, the opposite is true: Long-dated, higher quality bonds post the best results. Investors with in-depth investment processes that include strong tactical asset allocation can reposition their portfolios and outperform the buy-and-hold investor over time. (Janiczek & Company, Ltd. analysis of Bloomberg data, 2014)


Don’t assume your portfolio, wealth or fund manager will or can make timely tactical adjustments

Investors are often surprised to learn that they cannot expect timely tactical adjustments from their portfolio, wealth or fund manager. Mutual funds, with few exceptions, are designed to be fully invested in their defined asset class category with modest exceptions to account for cash reserves needed for daily redemptions. They may tactically adjust within sectors of their asset class category but typically not between asset classes. Portfolio and wealth management firms often do not have the philosophy or means to tactically adjust all client portfolios in a timely manner. A study by Curian Capital, LLC revealed that 69% of advisors did not change their clients’ portfolios in the face of market volatility.

Our advice here is to ask questions. Is your advisor prepared to adjust client portfolios in the event of a crisis or an investment opportunity? Can they provide examples of how long it has taken them to execute portfolio adjustments across their client base? Are they equipped to trade quickly across all clients? You may be surprised what you learn.

INSIGHT #6: Investors with in-depth investment processes that include strong tactical asset allocation can reposition their portfolios and outperform the buy-and-hold investor over time. While there is a time and place for buy-and-hold, it is not a strategy for all investment seasons and all points in an economic cycle.


This article is adapted from “Evidence Based Investing for High & Ultra-High Net Worth Investors,” a white paper published by Janiczek & Company, Ltd. The full paper is available hereAlso see our previous posts on asset allocationpassive investing, and tax strategies.

Janiczek® Wealth Management

Janiczek® Wealth Management serves high net worth and ultra-high net worth investors across the country, and has been named among the top, best and most exclusive wealth advisors in the nation multiple times. Contact Cathy Wegner to start the conversation!


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