What Is Tactical Asset Allocation (TAA)?
Let me explain tactical asset allocation directly: it's an active management strategy for portfolios where you shift the percentages of assets in different categories to exploit market pricing anomalies or strong sectors. This approach lets you, as a portfolio manager, add extra value by capitalizing on specific market situations. It's moderately active because you return to the portfolio's original asset mix once you've secured those short-term profits.
Tactical Asset Allocation (TAA) Basics
To grasp tactical asset allocation, you first need to understand strategic asset allocation. As a portfolio manager, you might create an investor policy statement (IPS) to define the strategic mix of assets in a client's holdings. You consider factors like required rate of return, acceptable risk levels, legal and liquidity requirements, taxes, time horizon, and unique investor circumstances.
The long-term weighting of each asset class is what we call strategic asset allocation. This mix helps you reach specific investment goals. For instance, a typical portfolio might allocate 10% to cash, 35% to bonds, 45% to stocks, and 10% to commodities.
The Usefulness of Tactical Asset Allocation
Tactical asset allocation means taking an active position on the strategic allocation and adjusting long-term target weights temporarily to capitalize on market or economic opportunities. Suppose data indicates a big increase in commodity demand over the next 18 months; you might shift more capital there to benefit. While the strategic allocation stays the same overall, your tactical mix could become 5% cash, 35% bonds, 45% stocks, and 15% commodities.
You can also make tactical shifts within an asset class. If the strategic 45% in stocks is split as 30% large-cap and 15% small-cap, and small-cap outlook is poor, you could temporarily adjust to 40% large-cap and 5% small-cap until conditions improve.
These tactical shifts usually range from 5% to 10%, and it's rare to go beyond 10%—that would signal a flaw in the strategic allocation itself. Remember, this isn't the same as rebalancing, where you trade to restore the strategic mix. Tactical allocation tweaks it briefly, planning to revert once opportunities fade.
Key Takeaways
Here's what you need to remember: tactical asset allocation involves actively adjusting long-term target weights for a short period to exploit market or economic opportunities. These adjustments can happen within an asset class too. In discretionary TAA, you adjust based on market valuations in the same market as your investment.
Types of Tactical Asset Allocation
TAA strategies come in discretionary or systematic forms. With discretionary TAA, you adjust allocations based on market valuations and changes in the investment's market. For example, if you hold a lot of stocks and expect bonds to outperform them temporarily, you might reduce stock holdings. Unlike picking individual stocks, TAA judges entire markets or sectors, so some see it as a supplement to mutual fund investing.
On the other hand, systematic TAA uses a quantitative model to exploit inefficiencies or temporary imbalances across asset classes. These rely on established financial market anomalies supported by academic and practitioner research.
Real World Example
In practice, 46% of respondents from smaller hedge funds, endowments, and foundations in a survey reported using tactical asset allocation to beat the market by following trends.
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