Fundamentals

  

The Tactical:

 

When you think of tactical management you should picture the idea of the manager hunting for what is next.

 

In essence, tactical managers are going to try and get "ahead of the curve" through research and focus on specific stocks or sectors.

 

For example, a manager can be tactical by deciding which individual stocks should be purchased within a market such as the S and P 500 index.

 

A manager can also be tactical by over emphasizing certain sectors such as having more US stocks and fewer International stocks.

 

Further, a manager can be tactical by moving money out of stocks and into cash and/or bonds if they feel the stock market is overheated

 

In each of these tactical examples you can see that the manager is making a decision to, at some level, time the market.  Through their analysis of both the fundamental and technical issues they arrive at the conclusion that they need to change direction in order to improve performance.

 

In attempting to move toward greater performance it may result in a change to the level of risk they are absorbing.  In a dramatic example, if the manager moves from 100% cash to 100% stocks because they believe stocks will outperform this is a dramatic increase in risk to the investor.

 

There is nothing wrong with this per se as long as the investor understands the tactical nature of the manager.  

 

The risks to the investor are obviously that the tactical manager gets it wrong and misses their mark.

 

If, however, the tactical manager gets it right and, for example, targets U.S. equities over the past two years, then they might outperform other basic asset allocation strategies.

 

As I said, when you think tactical, think "hunting for performance"

 

 

 

The Strategic:

 

 

Often when we think about strategic management we think about asset allocation and risk tolerance.

 

Rather than trying to "time" the market, a strategic manager might identify a mix of asset classes that they would like to use.  Some might be large company US equities; Medium sized US equities, international, and/or fixed income including government and corporate bonds etc. 

 

With this spread of asset classes in hand the manager will then try and assess the investor's tolerance for risk and, from the chosen asset classes, select the mix that best fits the investor.   

 

Once the mix is in place, the manager will rebalance the asset classes depending upon market performance to continually bring the risk profile back in line with the investor's risk tolerance. 

 

As a simple example, suppose an investor was 50% in stocks and 50% in bonds at the beginning of the year.  Let's say that during the year stocks outperformed bonds such that by the end of the year the investor's account had changed to an allocation of 60% value in stocks and 40% value in bonds.  To hold the investor's risk profile steady the manager would "rebalance" the account by moving 10% of the value from stocks to bonds and bringing it back to the original 50%/50% balance.

 

This strategic process, as you can see, does not try to time the market.  Its goal is to hold a position in many asset classes with the idea that it is unclear when different asset classes will outperform. 

 

In this way the manager could be said to be trying to "trap performance".   

 

If managed well this type of approach might be a slightly smoother ride given that many asset classes are present as opposed to a tactical manager that is focusing on a few targets.

 

But in years like the last two (in which mostly US equities alone did well) having assets in other classes can be a drag on the portfolios performance. 

 

Does this mean that Strategic Asset allocation doesn't work?  Not at all, it is just behaving this way given the current market environment.   If you have done a good job strategically building your portfolio it is not necessarily true that, given the last two years performance, you should abandon it now.

 

 

 

 

Conclusion

 

I am sure there will be arguments but I think there is obviously a place for both tactical and strategic management.

 

While the tactical manager will work to hunt returns by targeted selection, a strategic asset allocator will try and trap returns by diversifying asset classes and focusing on strong risk boundaries for the investor.

 

But from an investor perspective you should be clear on what type of management style your investment manager uses.  Without this knowledge it becomes very hard to evaluate their performance and, worse yet, might lead you to very bad behavior by jumping ship and unraveling your discipline at the wrong time.

 

In my experience investors have different personalities and will inherently prefer one style to the other (at least a little bit) and there is nothing wrong with this.

 

The point is, as an investor your behavior will drive a large part of your performance.  Knowing your investment manager and yourself will get you a lot closer to better behavior.

 

 

Cheers-

 

Tim