Should this occur, it’s likely that central authorities unwind quantitative easing (QE) and governments remove fiscal stimulus from the economy, ultimately translating into a resurgence in cross-asset class volatility.
Multi-asset managers will need to be nimble in terms of adjusting their asset class exposures; specifically, underweighting/overweighting those market segments deemed to be expensive/cheap, while also focusing on sector structuring, taking into consideration factors such as value, momentum, inflation and policy settings.
Where permitted, it’s expected that multi-asset managers will lean more heavily on tactical asset allocation (TAA) to navigate unknown market conditions and position their portfolios to achieve their investment objectives.
One issue, however, is that in our experience, few managers have demonstrated an ability to consistently add value through TAA. So what is TAA, and when and how can it add value to portfolios?
What is tactical asset allocation (TAA)?
In its simplest form, TAA is described as the process whereby investment managers move portfolios away from their Strategic Asset Allocation (SAA), where it’s deemed that markets have strayed from fair value and there exists an opportunity to enhance portfolio outcomes.
What is the attraction of TAA?
Proponents of TAA believe that it can be used to improve portfolio efficiency. In this regard, TAA has dual objectives – namely, to enhance returns and reduce overall portfolio volatility.
Regarding the former, managers implementing TAA do so for the purpose of supplementing (as opposed to underwriting) total portfolio performance.
Consistent with this view, we note that across our rated multi-asset managers, the targeted contribution from TAA commonly ranges from 5-20%. With respect to volatility, TAA is focused on capital preservation and minimising drawdowns in risk-off environments.
To achieve these objectives, multi-asset managers target mispriced asset classes that are expected to mean revert. Effectively, they allocate capital away from those asset classes deemed to be expensive or at risk of underperforming, in favour of others considered to be undervalued or positioned to outperform.
What are the pre-conditions for successful TAA?
To be successful in implementing TAA, portfolio managers must demonstrate an ability to identify mispriced asset classes and proficiency in timing market inflection points.
In our view, multi-asset managers that have had success on each of these fronts are those that implement a mix of qualitative and quantitative techniques.
Is TAA suited to a particular investment horizon?
Presently, there’s no universally accepted view on the investment horizon over which TAA is best suited. Consistent with this, we’ve observed a wide divergence of views expressed across our multi-asset sector participants.
There exists a broadly even split between those managers that suggest TAA is a tool best suited to expressing shorter-term views (ie. less than one year) and others that believe TAA can have more enduring benefits (one to three years).
In our opinion, TAA should be considered a shorter-term portfolio management tool, consistent with the notion that it seeks to supplement portfolio returns. We believe that if TAA positions persist for extended periods, these may be better expressed through strategy selection or refinements to a fund’s SAA.
How does TAA compare to other forms of active asset allocation?
There exist several alternate forms of active asset allocation (AAA) strategies implemented by multi-asset managers which have a similar desired outcome to that of TAA. This includes dynamic asset allocation (DAA), strategic tilting and overlays.
While the common thread across each of these techniques is the goal of delivering investment outcomes that exceed a fund’s SAA, differences also exist. These largely extend to stipulated investment horizon.
Is TAA suited to a particular investment approach?
Conceptually, TAA is relevant to managers implementing either a single or multi-manager approach to portfolio construction. That said, TAA tends to be more of a tool of choice amongst single managers, an outcome which we believe is intuitive.
By definition, a single manager is one that gains asset-class exposure through investment capabilities offered across internal distribution channels. While a key benefit is cost efficiency, a drawback is that investment choice is often limited which can in turn lead to less efficient portfolio outcomes. This is particularly relevant for those managers who have a relatively narrow suite of sector specific strategies from which to select and structure asset class exposures.
To help mitigate this perceived shortcoming, many single managers have dedicated considerable resources to building a TAA platform, a trend that has not been as evident across the multi-manager cohort of multi-asset strategies. Multi-managers have instead tended to focus their efforts on identifying best in class offerings and the blending of complementary strategies to achieve more bespoke sector exposures.
What does this mean in the current market environment?
Many TAA managers have faced challenges in recent times, not least the advent of QE which has translated into a reduction in cross-asset class volatility and an expansion in valuation multiples.
In our opinion, higher market volatility increases the number of opportunities to alter portfolio positioning to exploit mispricing.
As such, increased market volatility is likely to be beneficial to TAA managers, who have the flexibility to react more quickly to market inefficiencies than their SAA-only counterparts.
It's important to note, however, that TAA introduces market timing risk and as a result, increases the potential range of investor outcomes compared to their SAA counterparts.
Andrew Yap, head of Australian fixed interest and multi-asset, Zenith
