Tactical ETFs: Tactfully No, Thank You?
“Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.” – Sun Tzu
May 2020. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Tactical investing aims to deliver better risk-adjusted returns and/or reduced drawdowns
- Tactical ETFs have not achieved either objective in recent years
- It is challenging to explain the consistent underperformance across different types of tactical ETFs
INTRODUCTION
Every investor is a tactician, whether they actively try or not. Warren Buffett and his lieutenants at Berkshire Hathaway pursue a well-known strategy of buying high-quality companies trading at moderate valuations for the long-term (“quality merchandise at a discount”), but still, tactically adapt their investment portfolio to the changing environment. They did this most recently, for instance, by selling their stakes in US airlines like Delta and United when their outlook became less attractive in the post-COVID-19 world.
It can be argued that even long-term buy-and-hold investors are tactically allocating capital when they decide on an asset allocation mix, portfolio rebalancing dates, investment products, capital deployment plans, etc. No one simply holds the market portfolio – even in the simple case where you only held the market, decisions regarding dividends and new cash would be tactical.
Some investors explicitly describe their investment process as tactical asset allocation, typically with the goal of avoiding large losses or minimizing drawdowns. Given the current COVID-19 crisis, it is interesting to explore how effective this type of strategy was in terms of capital preservation.
In this short research note, we will investigate the performance of tactical asset allocation ETFs.
DEFINING TACTICAL ASSET ALLOCATION
Defining tactical asset allocation is challenging as tactical is largely in the eye of the beholder. Discretionary fund managers change their portfolios frequently and many of their decisions can be categorized as tactical. The same applies to systematic strategies like multi-factor products that adapt the factor mix according to the market structure. However, many of these changes are marginal rather than dramatic, making it difficult to come up with a simple definition of tactical vs strategic.