Tactical asset allocation has been gaining traction lately among institutional investors. Pensions & Investments, an industry publication, just reported on October 8th the results of a survey of institutions by asset manager Pyramis. Their survey showed that 41% of respondents became “more tactical in their asset allocation over the past three years”, and the percentage of pension managers pursuing a combined “strategic and tactical” approach jumped to 40%-50% range from single digits ten years ago. Earlier this year, Forbes posted a piece by Sean Hanlon, Chairman and CEO of Hanlon Investments, reporting how “tactical asset allocation can improve risk-adjusted returns.”
The earlier disrepute of TAA was unjustified, in our view, and the increased popularity is a very positive development for the industry. Research back in 1980’s (Brinson et.al.) showed that about 90% of a typical balanced pension portfolio risk and return comes from Policy asset allocation. So, there is great potential for adding value to client portfolio returns over index by actively managing asset allocation.
Of course, the market largely forced the change. While managers were content with buy-and-hold, long-term, static asset allocation prior to 2002 because it worked well, the bear markets of 2002 and 2007-2008 brought the decade’s total return for U.S. equities close to zero. However, tactically positioning portfolios in advance of 1-3 year up- or down-cycles would have made tremendous difference.
Even if implemented, performance of TAA strategies is often lacking. In our recent white paper, we highlighted some of the reasons for this underperformance. TAA decisions have to be systematic, based on a consistent statistical model that provides proven forecasts of asset class returns. While developing such a model may be costly, could take years, and success would still not be guaranteed, the cost-effective way of obtaining the results is partnering with a research firm that provides return forecasting and/or asset allocation research.