What’s the Difference?
January 11, 2011
“Rather than an absolute return strategy, where if you lose money you are a bad market timer, tactical asset allocation is built around more of a relative return story,” he explained. “You try to be underweight when an asset class looks a little risky and overweight when it looks a bit better. You don’t simply hold multiple asset classes and hope some zig while others zag. Instead, you try to not own as much of asset classes that may go down, hoping to make money in a bull market and not lose quite as much in a bear.”
Kitces illustrates the fuzziness in the distinction between tactical asset allocation and market timing; what he describes as tactical asset allocation is merely a milder version of his view of market timing.
In a recent post on his blog Nerd’s Eye View, written jointly with Ken Solow, Chief Investment Officer for Pinnacle Advisory Group, Kitces argued that the definition of market timing as retail day-traders moving in and out of positions based on very short-term market predictions needs to be updated. After all, while tactical investing involves subtle rather than wholesale portfolio moves, it, too, is opportunistic. And it’s that characteristic that may prompt clients comfortable with a strategic buy-and-hold approach to worry that their advisor is abandoning his investment management discipline by making a move to dial down portfolio risk or gain exposure to a new asset class.
Frequency of trading cannot be what distinguishes market timing from tactical asset allocation. Consider David Swensen, who heads Yale’s investment office. Swensen rebalances his portfolios daily, but few would call him a market timer.
Communicating with clients
While differentiating market timing from tactical asset allocation proved difficult, a clearer consensus emerged around how to communicate portfolio moves to clients.
Kitces, whose firm transitioned from a passive strategic approach to tactical asset allocation in 2002, tempers clients’ fears that tactical investing is thinly cloaked market timing by pointing out that the act of rebalancing annually to one’s strategic asset allocation involves an element of market timing. “Many advisors who had previously disagreed with me that rebalancing is a form of market timing came around to my point of view during the remarkable volatile fall of 2008,” he said. “The difference between rebalancing on the best day or the worst day of the market in September and October 2008 was a decade’s worth of returns because markets moved 10 to 20 percent over a couple of days.”
Glenn Frank, Director of Investment Tax Strategy at Lexington Wealth Management in Lexington, Massachusetts, has always used a tactical investment approach using fundamental valuations to identify under- and over-valued asset classes. His decisions are guided by a question he says few advisors ever ask their clients: Is the portfolio a means to an end, or an end in itself? “If we agree the portfolio is a means to an end, then it’s easier not to get caught up in the moment trying to beat the market and instead work toward goals by focusing on risk management and tactical shifts,” he explained. “To be a strategic allocator and continually have rebalanced back to target in 2008 for fear being labeled a market timer would have really compounded some serious losses.”
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