I Poo-Poo TAA and Readers Respond
I wear it as a badge of honor that my recent posts poo-poo’ing the future of tactical asset allocation (and its infinite reincarnations) have been consistently met with loud disagreement.
Folks getting upset with you isn’t necessarily a sign that you’re doing the right thing, but never having folks get upset with you is a sure sign that you’re not. Such is the nature of challenging conventional wisdom.
These very healthy discussions have helped me to crystallize and simplify my logic:
1. Almost everything in today’s market is too well correlated with equities, with the exception of just a handful of asset classes.
2. Treasuries (and similar assets), the most significant of those few low-correlation asset classes, is mathematically guaranteed to underperform in the future. It may not happen tomorrow, but it will happen.
3. Ponder the implications of the combination of #1 and #2 and riddle me how the super smooth backtested equity curves that the investing world is chasing, which inherently require effective diversification, represent realistic expectations for the foreseeable future.
Some smart responses have been:
1. Trend-following and momentum, market anomalies that have existed for well…as long as markets have existed, will be enough to overcome #1 and #2. (I disagree: real trading is difficult enough without entirely foreseeable holes in your game plan)
2. Alternatively, all of this is going to hurt TAA, but it’s still the best game in town and certainly better than buy & hold. (I don’t think it’s the best game in town, but I do agree it’s superior to B&H)
3. There are other sources of yield with low correlation to equities (including during market shocks) that will not be negatively impacted by rising rates.
4. Or alternatively, other low correlation asset classes, like gold or currencies, are going to make up for the role Treasuries play in most TAA backtests.
Those last two are very interesting to me. If I were going to continue putting my dollars into TAA, my energy would be focused there. These problems may not be insurmountable.
To date I haven’t seen anyone make a real effort to be the devil’s advocate when tackling this subject. I’m not talking about describing solutions. I’m talking about modelling solutions.
I’m not saying that finding yet another super duper way to measure momentum isn’t useful, but I am saying that when an obvious hole in your strategy is staring you in the face today, you don’t keep referring back to the past as justification to ignore it.
Just my (entirely biased as a short-term trader) $0.02…
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Filed under: Tactical Asset Allocation | 21 Comments