Tactical Asset Allocation and Market Timing: What's the Difference?
Why is it that the industry dismisses significant changes to portfolio allocations as “market timing” transactions but embraces the subtler “tactical shifts” many advisors are making in the current, transitional market? As advisors debate the nuances of that question, the more relevant question may be: How would you respond if a client asked you to explain the difference between market timing and tactical asset allocation?
I spoke with several prominent industry practitioners to better understand the distinction between much-maligned market timers and tactical asset allocators, and to find out if there really is a difference between the two.
Nobody I spoke with called themself a market timer but, as you will see, their definitions were more art than science.
Nathan Sonnenberg, Chief Investment Officer at Fortigent, LLC, a Rockville, Maryland provider of investment research and performance reporting, insisted the difference between market timing and tactical asset allocation is black and white. “Market timing is an all-or-nothing approach applied to a specific asset class or area of the market,” he explained. “Should you sell out of stocks? Should you sell all your municipal bonds? Should you invest everything in commodities because emerging markets are poised for a decade of growth?”
Conversely, Sonnenberg said, tactical allocations involve relatively minor adjustments to a strategically allocated portfolio. “In a traditional portfolio split 60/40 between stocks and bonds, you might decide to increase your exposure to fixed income or, within the equity allocation, favor emerging markets over US or small-caps over large-caps to take advantage of differentials you perceive in the market,” he explained.
The all-or-nothing distinction was a common thread among those I interviewed. Sometimes, however, a market timer may stay fully allocated to a single asset class. Consider a day trader, who epitomizes market timing. Many day traders don’t routinely switch asset class allocations; they may stay invested in equities over an extended time period, albeit adjusting their positions daily.
Michael Kitces, Director of Financial Planning at the Maryland-based Pinnacle Advisory Group, agreed that market timing and tactical asset allocation are differentiated by degree and magnitude. “A five-percent shift is tactical, whereas market timing is all-or-nothing,” he said. Kitces also pointed to a difference in expectations. When advisors move all-in or all-out of an asset class, he said, the implication is that they seek to be all-in when markets are going up and all-out when markets are going down.