What is Tactical Asset Allocation? All You Need to Know

The right investment strategy is key to the desired return on investment. The thing is, there isn’t always one right strategy that works for all investment opportunities. Yet, asset allocation is one strategy that every fund manager banks on. The asset allocation’s meaning is simply deciding how much to invest in which asset. Although it may seem quite straightforward, the right allocation can help maximise profit. This is where tactical asset allocation comes into the discussion.

Consider tactical asset allocation a flexible strategy well-adapted to the market conditions. To understand and utilise the benefits of this strategy, investors need a closer look at its definition, mechanism, different types, and features.

Defining Tactical Asset Allocation

It is basically a short-term, actively managed investment strategy where investors or fund managers address the latest market trends and economic indicators. Unlike keeping the investment fixed for a predetermined asset combination, such as in strategic allocation, tactical allocation provides the flexibility to temporarily increase or decrease exposure to certain asset classes and capitalise on available opportunities.

Such a strategy is a key component of certain multi-asset allocation funds (MAAF), where the portfolio can be tactically adjusted to maximise returns and mitigate risks in accordance with market direction.

How Does Tactical Asset Allocation Work

Adaptability is at the centre of tactical allocation. By not restricting the investment to a predetermined strategy and by allowing investors and fund managers to study and act according to economic shifts, market cycles, and short-term opportunities, tactic allocation offers great adaptability.

Let’s say, an investor holds a balanced portfolio of:

• 50% equities

• 30% bonds

• 20% cash

According to market reports, if a new trend emerges, investors can allocate 60% to equities, 20% to bonds, and 20% to cash. Once the market settles, they can return to their initial position. This type of flexibility helps maximise return potential without compromising on long-term objectives.

Features of Tactical Asset Allocation

The following characteristics differentiate tactical allocation from other strategies:

• Active Management: Ongoing evaluation of markets and economic indicators.

• Short-Term Adjustments: Positions are short-term.

• Risk Management: Less exposure to poor-performing assets and more to better-performing assets.

• Flexibility: Investors may rapidly adjust to changing market conditions.

Advantages of Tactical Asset Allocation

There are several benefits of going with tactical allocation when investing:

• Maximises Return Potential: Return potential is maximised by modifying investment according to shifting market trends.

• Enhances Portfolio Performance: It can be used to improve risk-adjusted returns if utilised sensibly.

• Responds to Market Changes: The portfolio can be in alignment with the existing market conditions.

• Diversification Opportunities: Investors are provided an opportunity to invest in new asset classes on a short-term basis.

Types of Tactical Asset Allocation

Here are the different types of tactical allocation strategies investors and fund managers use:

• Systematic Tactical Asset Allocation: The idea is to depend on quantitative analysis and data to identify short-term opportunities. Temporary price inefficiencies are found using statistical examination.

• Discretionary Tactical Asset Allocation: The fund manager or investor uses experience, judgment, and intuition to make decisions, not necessarily relying only on data.

• Hybrid Tactical Asset Allocation: Combining both systematic and discretionary approaches to find the best results.

Reasons for Tactical Asset Allocation

Why do managers or investors use this strategy? Some common reasons are:

• Taking Advantage of Market Inefficiencies: If prices are fluctuating too much, tactical allocation will be able to take advantage of it.

• Cushioning Losses: Moving into defensive assets such as bonds or gold can mitigate losses in bear markets.

• Hedging Macroeconomic Risks: Tactical allocation can better manage interest rate fluctuations, geopolitical incidents, or inflationary pressures.

Tactical Asset Allocation vs. Dynamic Asset Allocation

The table below summarises the differences:

Challenges and Considerations

Although tactical allocation has benefits, it also poses threats. These are:

• Incorrect Timing: Overestimating or underestimating changes in the market can lower returns.

• Increased Transaction Costs: Repeated switching raises costs.

• Active Monitoring Required: Needs time, expertise, and resources to be effective.

Conclusion

Tactical allocation presents a strategic opportunity to adjust and capitalise on short-term market trends. Temporary fluctuations in assets can’t always be predicted, but opportunities can be capitalised on, risks can be mitigated, and better diversification can be achieved with the tactical allocation. While it does involve continuous monitoring and is potentially costly, if implemented correctly, tactical allocation can significantly contribute to portfolio returns. For those considering diversified portfolios, such as MAAF, it is essential to understand tactical asset allocation to appreciate how active changes contribute value.

Disclaimers:

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.