What is Tactical Asset Allocation?
Tactical asset allocation is an active asset allocation strategy that includes management of risk through portfolio rebalancing to a flexible asset allocation target.
Different valuation levels should require a different asset allocation of your capital. One of the most important concepts in value investing is to be careful or prudent about the price you pay. It’s not possible to do this without changing your allocation to asset categories (i.e. stock, bonds, cash) after assets make large price swings.
A tactical asset allocation provides the value investor a dynamic asset allocation strategy that adjusts to favorable and unfavorable valuations. Instead of a strict fixed percentage (strategic asset allocation) you have greater flexibility because you choose from a range based on current conditions.
“It’s essential for investment success that we recognize the condition of the market and decide on our actions accordingly.”
Howard Marks
The value oriented investor wants to allocate more to assets that were priced the farthest below its real or intrinsic value. Assets which are priced above their real worth can be completely avoided or minimized.
As an example, consider your asset allocation during the first decade of this century. Should your portfolio have held the same percentage of equities when valuations were sky high (i.e. 2000) compared to after they fell 57% in 2008-09? Of course not.
The purpose of a tactical asset allocation strategy is to increase risk adjusted returns as compared to a fixed or strategic asset allocation. The idea is to be more aggressive (invest more money) in lower risk undervalued assets, and be more conservative (invest less money) in higher risk overvalued assets.
We know from history that when asset prices are lower than their fundamental or intrinsic value they provide higher than average rates of return in the long run. When asset prices are expensive compared to their fundamental value they provide lower than average rates of return in the long run.
Adopting a tactical asset allocation is one of my five portfolio risk management strategies. Investors can take advantage of volatility if they understand market emotions affect asset prices. When focusing on value, investors can look for opportunities in assets that are experiencing extreme pessimism, and look to take profits in assets that are experiencing a buying euphoria.
