Tactical Asset Allocation

Tactical asset allocation refers to the practice of changing the composition or style of a portfolio based on market conditions. An example would be selling a portion of the portfolio's bonds and buying stocks when the earnings yield on stocks has risen above a benchmark interest rate. Of course, the parties on the other side of these trades are well aware of these changed market conditions, so the prices paid and received by the tactical allocator are fair and impart no expectation of an additional risk-adjusted return. Figure 6-7 displays the results of a study of the only 24 mutual funds with a 20-year record based on tactical asset allocation as of December 31, 2013. As the chart shows, only two funds plot above the line of index portfolios. While 2 of 24 (8.3%) is rather dismal to begin with, the true percentage is much lower because we are only looking at funds that survived for the last 20 years. An investor who chose a tactical allocation fund 20 years ago had a very small chance of both keeping the same fund and beating a risk-appropriate allocation of index funds.

Figure 6-7

Step 6BondsStocksFair Price