Tactical Asset Allocation: It Really Is that Good
Inspired by the excellent work of Mebane Faber I’ve been tinkering obsessively with a Tactical Asset Allocation (TAA) model and I’ve come to the conclusion that TAA really is that good (as one component of a broader portfolio…more on this later).
This post is a primer for those unfamiliar with TAA, and in a follow up, I’ll take a more technical look.
What is TAA?
Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a portfolio’s asset allocation…Unlike stock picking, in which the investor predicts which individual stocks will perform well, tactical asset allocation involves only judgments of the future return of complete markets or sectors.
Three big differences between TAA and what we do (active trading):
First, the focus is on asset classes (not individual stocks, funds, etc.) Second, though the definition doesn’t strictly call for it, TAA tends to trade less frequently and ignores more day-to-day market noise. And third, TAA relies more on diversification to provide for risk management (as opposed to entry/exit points).
When I talk about TAA I’m using Faber’s published model as a jumping off point (“standing on the shoulders of giants” and all that jazz), so the focus is on trend-following/momentum.
My end goal is a strategy that trades infrequently (once per month or less), selecting from a diversified basket of asset classes those that are exhibiting the strongest trend/momentum, and allocating the portfolio between them in a “smart” way (i.e. in a way that maximizes expected return versus volatility).
My basket includes: U.S. Stocks, China Stocks, Japan Stocks, Gold, Oil, Commodities, Real Estate, and U.S. 10-Year Treasuries.
Why Faber’esque TAA?
Active strategies (including our own) are based on market inefficiencies and anomalies that are by their nature fleeting.
Folks who trade the way we trade are in a perpetual quest to stay ahead of the curve because the doors of short-term opportunity are forever opening and closing.
Contrast that with tried-and-true trend-following, which works as well today as it did 100 years ago. The lowly 50/200-day moving average crossover, that’s been around since the dawn of ticker tape, was more effective over the last decade than at any point since at least 1930 (read more).
It’s that kind of reliability that makes sleeping at night easier on us active traders.
Why not just trade trend-following/momentum?
Because the successful among us will, at the end of the day, soundly outperform the best TAA strategy. The point isn’t to replace what we do now, but to provide a stable foundation for a portion of our portfolio that’s reliably rooted in the long-term.
1. I’ll post a follow up this week taking a more technical look at Faber’s TAA model versus our own.
2. I’ve allocated a portion of my own portfolio to trading our TAA model (I eat my own cooking). I’ll be sharing our picks monthly and tracking performance here on the blog (a value-added service of being the best readers in the blogosphere).
[Edit: click for a summary of all posts in this series on TAA]
P.S. to learn more about Faber’s TAA model pick up his book The Ivy Portfolio.
. . . . .
Filed under: Tactical Asset Allocation, Trading Strategies | 21 Comments