Defining Tactical Asset Allocation

What is a tactical asset allocation strategy?

August 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Tactical asset allocation ETFs charge high fees (0.92% pa) that need to be justified
  • The active share of TAA strategies can be measured via regression analysis
  • High active share does not automatically create value, but offers value-creation potential

INTRODUCTION

The life of equity fund managers is getting increasingly difficult. Many active managers had realized decades ago that creating outperformance is hard, so changed their strategy to essentially provide index-like performance. There is significantly less career risk for a fund manager if the performance is more or less like the benchmark. A generation of index-huggers was thus borne.

However, benchmarks became investible with the rise of ETFs, and offering benchmark-like products with higher fees became less acceptable. Capital allocators started calculating the active share of mutual funds and challenging the fund managers with low ones. Be active, or be gone, is the new motto.

Evaluating fund managers focused on stock markets is relatively easy given obvious benchmarks like the S&P 500. Ideally, the fund managers consistently outperform their benchmark. However, evaluating tactical asset allocation ETFs is more challenging as there are no clearly defined benchmarks. Furthermore, the lines between strategic and tactical asset allocation often blur. There is little justification for charging high fees for strategic asset allocation as investors can replicate this efficiently themselves (try Finominal’s Alpha Analyzer for alpha and contribution analysis).

In this research note, we will evaluate a framework for identifying tactical asset allocation (“TAA”) strategies.

EVALUATING TACTICAL ASSET ALLOCATION STRATEGIES

TAA strategies invest across asset classes dynamically. Many focus just on equities and bonds, while others also include REITs, currencies, and commodities. A managed futures strategy, also called a CTA, that goes long or short hundreds of asset classes, is the ultimate version.

We focus on TAA strategies that are available via ETFs traded in the U.S. stock market and that have a track record of at least three