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Investors can use various active management strategies to manage their portfolios. Usually, they hire a portfolio manager to track the performance of their portfolio. The managers can make decisions regarding the portfolio with the goal of outperforming the market. However, they must also manage the risks associated with it. One strategy that is common in active management is Tactical Asset Allocation.
What is Tactical Asset Allocation?
Tactical Asset Allocation (TAA) is an active management portfolio strategy that focuses on three primary asset classes. These include stocks, bonds, and cash. The goal with TAA is to shift the percentage of assets held in these categories to benefit from market pricing anomalies. With this strategy, portfolio managers can create extra value by exploiting various market events or situations.
Usually, managers determine a balanced mix of several asset categories. However, they may change this mix to benefit from anomalies. Once they have exploited the market situations, they can revert to their original asset mix. This way, they can ensure both diversification of portfolios and higher returns.
How does Tactical Asset Allocation work?
Investors can use the tactical asset allocation by themselves or hire a portfolio manager to take care of it. Usually, the portfolio manager determines a prudent mix of assets that suits the investors’ risk tolerance. Similarly, the manager also considers the investment objectives for the portfolio when deciding on the asset mix. Managers divide the portfolio into three asset categories, which include stocks, bonds, and cash. They use the determined mix for the allocation.
However, the mix does not remain constant. The manager will change the allocation depending on the prominent market and economic conditions. The allocation to a particular asset may vary according to these conditions and the investors’ objectives. Therefore, it may be neutral-, over-, or under-weighted. Managers may include these factors as a part of the investment policy statement.
For example, managers may use the following simple mix of assets in a typical portfolio allocation. The percentage for each asset class represents its weight.
Stocks = 50%
Bonds = 30%
Cash = 20%
The above is an example of the long-term mix that managers will follow to help investors reach their specific goals. However, they may change it when they can find any anomalies in the market. Once they exploit those conditions, they will return to the long-term mix.
What is the importance of Tactical Asset Allocation?
Tactical asset allocation can be beneficial for investors for several reasons. Firstly, it allows investors to increase their returns. By changing their asset mix within a portfolio to benefit from market conditions, investors can increase their returns.
Similarly, it allows for adaption according to market conditions. Unlike passive management strategies, tactical asset allocation changes according to the market. Therefore, investors can benefit from any changes in the market and not suffer due to adverse fluctuations.
Most importantly, tactical asset allocation promotes diversification. Investors can diversify their portfolios by allocating them to different asset categories. Similarly, TAA allows investors to choose their own asset mix, allowing for even better flexibility.
Conclusion
Tactical asset allocation is an active management strategy. Investors use it to divide their portfolio into various asset categories. Once they identify any market anomalies that they can exploit, they can change the asset mix to generate higher returns. After that, they can revert to their original mix and wait for the next opportunity.
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