Executive Summary
As the terms "being tactical" or "tactical asset allocation" become increasingly popular, more and more advisors now must decide whether they, too, are "tactical" or not when describing their investment process and philosophy to current and prospective clients. Traditionally, the dividing line was simply whether one was active or passive, a determination that could be made pretty clearly by looking at the portfolio: were there a bunch of actively traded stocks and bonds, or a series of actively managed mutual funds that did the same thing? With tactical, though, it's no longer sufficient to simply look at whether there are stocks and bonds in the portfolio, or actively managed mutual funds; instead, some tactical investors implement their strategies by selecting only passive index funds, but still utilize them in an active, tactical process. Which begs the question: where exactly do you draw the line on being tactical?
The inspiration for today's blog post comes from a recent conversation I had with another financial planner, who stated that he's not a tactical investor... he simply makes shifts to his portfolio every year or two when he updates his capital market assumptions and adjusts accordingly. To which I replied, "isn't that being tactical!?" Where do you draw the line?
To me, the essence of being tactical means making making changes to your portfolio based on changing forecasts of the future; those forecasts could be economic, market trends, updated capital market assumptions regarding returns and standard deviations and correlations, or something else. The point is simply: do you take a view of the future, can that view change over time, and do you change your portfolio in response to the change in your view? If the answer to that series of questions is "yes", then the process is tactical.
Notably, I don't think being tactical necessarily has a frequency requirement. As my planning friend noted, "I don't see how I can be tactical, the changes only occur once every year or two." Yet the underlying process is still built on a forward-looking process, and one where the forward-looking view can change over time, and the portfolio is changed in response. As far as I can see, that's still a tactical process, albeit one with infrequent adjustments. You don't have to be frequently tactical to be tactical (nor do you need to make extreme "market timing" style allocation changes).
I realize that when it is construed in this manner, a LOT of planners might be characterized as being tactical. Whether it's because they have a regular process to update their capital market assumptions and thereby alter their portfolio, or because they're a lot more worried about future inflation than they used to be so now they buy gold in all client portfolios, or because they own more short-term bonds in today's environment due to a fear of rising rates. All of these alterations entail a change to a forward-looking forecast that resulted in a change to the portfolio; the process itself is tactical.
So what does it mean if many planners are actually at least "a little" tactical? Personally, I hope it means we can stop spending so much time arguing about whether someone is active or passive, and instead spend time where it matters: talking about HOW you develop your forward-looking forecasts, what factors you use, and how to do it better. Because in practice, while I believe that the definition of tactical set forth here would cause MANY planners to be characterized as tactical, I don't believe that most planners are really spending the time they should to ensure that their forward-looking views are well researched and founded and that the investments they implement in response are logical and appropriate. I fear that some adjustments are far more "off the cuff" based than they really should be, based on some article we read or something we heard at a conference.
But the bottom line is that I think, deep down, most of us actually are at least a little tactical. We want to be, to respond to the market environment we're in. We want to be, to respond to clients who are struggling to generate the financial success they wish to achieve in this difficult decade. Certainly, there are a subset of planners and investors who are what I would call genuinely, strictly passive, and do not make any forward-looking adjustments to the portfolio at all. But for most of the rest of us, those changes do happen. We may not have a great system for how we determine and implement them, but the process occurs nonetheless. Maybe we should just spend more time trying to get better at that part.
So what do you think? Is this a fair characterization of being "tactical" in the portfolio? If viewed in this manner, would you call yourself tactical? How many of your peers would you consider to be tactical? And do you think that's a "good" thing, or a "bad" thing?
I reject the idea that there is anything “tactical” about changing one’s stock allocation in response to a dramatic change in the level of risk associated with stocks. These sorts of changes are strategic changes.
Bogle says that investors should lower their stock allocations as they age because the hit that comes from a big price drop is worse when it comes closer to retirement. Is there anyone who would refer to such allocation changes as “tactical”? They are strategic. The investor has determined that he can only handle so much risk. When conditions change so that he is taking on more risk than is suitable for someone with his risk tolerance, he needs to adjust his stock allocation to maintain a realistic hope of seeing his investing STRATEGIES bear fruit.
So it is when dramatic valuation swings change the riskiness of stocks dramatically. Is there anyone who would say that stocks were equally risky in March 2008 (pre-crash) and in March 2009 (post-crash)? If the risk associated with the asset class has changed dramatically, isn’t an allocation shift REQUIRED for those seeking to keep their strategies (which obviously were formed with risk considerations in mind) on track?
It is the motive for the allocation change that determines whether it is tactical or strategic. If you are taking a guess as to where prices might be headed in the short-term, that’s a tactical maneuver. If you are making a change needed to keep your risk profile roughly constant, that’s a strategic requirement.
Rob