Tactical investing is becoming more popular for both clients and advisors, according to a SmartMoney article by Charles Passy, but what tactical investing, anyway?
There seems to be some disagreement as to what the term really means.
Passy, whose article was carried in the WSJ, considers it “shifting money among asset classes to dodge market crises based on market conditions.” That would appear to be a smarter approach than buying and holding the same stocks for years to come, regardless of conditions — a strategy that has performed poorly since 2000.
Its critics, however, compare tactical strategies to market timing, pegging it as more akin to trading than investing. They can point to studies that show market timing can hold back returns over the long haul.
In truth, there are a number of approaches to tactical investing. All of them do involve adjusting investment exposure based on market risks, so there is an element of timing the markets. But they are not the same as the market-timing strategies used by short-term traders.
Tactical investing, more than anything, is an acknowledgement that investment vehicles should have both a gas and a brake pedal. It makes sense to hit the gas when market rallies are emerging, economic sentiment is low and rising, and valuations are relatively low.
When the opposite is true, it’s time to be more cautious, which tactical investing affords. You really don’t want to lag the market when it’s in deep decline. It’s just the way percentages work. Lose 30% of a $1 million portfolio during a rough patch, and it can take you six years to break even if you gain only 6% a year.
Consider how different classes of stocks have performed historically against each other and against bonds. This table from Callan shows the yearly performance of various U.S. equity slices, international emerging markets and developed markets, and a broad bond index. Click to enlarge:
A good manager of a tactical investment strategy hits the gas and pumps the brakes in an effort to reduce volatility, avoid the big losses, and maintain exposure to growth areas – the blocks at the top here. They do so with an eye toward long and intermediate-term market cycles — not the short-term cycles favored by traders.
The main alternative to tactical strategies is to buy-and-hold — an approach that simply doesn’t work if you buy near a market top, as Bill DeShurko, manager of the Dividend and Income Plus model, explains.
An investor in the S&P 500 SPDR (SPY) from 2000 through 2010 could have had anywhere from a negative 6.46% to a positive 18.67% annualized return depending on when they bought in, DeShurko notes, showing that returns are not always in line with the amount of time spent in the market. “Run away when someone tells you anytime is a great time to invest,” DeShurko says.
He notes that using even a fairly simple long-term timing strategy involving a 200-day moving average more than doubled the average annual return from January 1, 2000 to the end of September, 2012. It’s proof, he says, that simple tactical techniques can work, and DeShurko uses the 200 DMA in his own process.
One additional knock on tactical strategies is that not all of them of course succeed in beating the market or in lowering volatility. And investors generally must pay higher fees than comparative buy-and-hold (or buy and rebalance) strategies that can be performed with indexes and ETFs.
At Covestor, we offer a marketplace for a variety of investing strategies. To help find a good one with a tactical approach, we recommend some of the following criteria:
- Look for a long track record of generating desirable returns, ideally with equal or less volatility than the overall market.
- Pay attention to max drawdown, as well as how the tactical investment strategy performed in previous market downtrends.
- Watch out for high turnover of positions, which can result in higher transaction fees and taxes.
- The lower the better as far as fees go. It is unnecessary to pay any more than a 2% fee for assets under management. You can find a potentially strong managed investment plan for significantly less than 2% in fees – and if the manager implements the tactical moves well, that can more than pay for itself.
Any investments discussed in this presentation are for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Further, the reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions made by model managers in the future will be profitable.