Key Points:
- Tactical asset allocation (TAA) involves temporarily deviating from the long-term strategic asset allocation (SAA) to take advantage of short-term opportunities.
- Asset allocation is a key driver of investment returns, with SAA accounting for about 90% of the variation in returns.
- TAA adds value by overweighting or underweighting asset classes based on expected performance.
- TAA decisions are influenced by the current stage of the business cycle, expected inflation, changes in monetary policy, and asset riskiness.
- TAA provides flexibility in response to changes in market conditions and can help optimize portfolio returns.
Strategic asset allocation (SAA) is a long-term investment strategy that determines the appropriate allocation of assets based on an investor’s risk tolerance and return goals. While SAA is important in providing a benchmark for the portfolio’s asset mix, tactical asset allocation (TAA) is equally valuable in taking advantage of short-term opportunities.
TAA involves temporarily deviating from the strategic weights assigned in the SAA process to take advantage of market conditions and generate added value. Research has shown that asset allocation explains about 90% of the variation in investment returns, highlighting the importance of considering TAA.
One key advantage of TAA is the ability to adjust asset-class weights based on the expected performance of those asset classes. By overweighting or underweighting asset classes relative to their strategic weights, TAA can potentially enhance portfolio returns. This tactical overlay strategy, according to experts, can add value to an investor’s portfolio.
Decisions regarding TAA are guided by various factors, including the current stage of the business cycle, expected inflation, changes in monetary policy, and the riskiness of assets. Analyzing valuation, economic data, technical indicators, and sentiment variables can help identify the asset classes that are currently favored by market conditions.
TAA provides flexibility in response to changes in market conditions. As the era of loose monetary policy comes to an end, an effective TAA process can leverage deviations from expected long-term returns and perceived disequilibria. This flexibility is particularly valuable as the capital markets normalize.
While TAA can be a valuable source of tracking risk, it also involves considering the costs of tactical adjustments. However, the potential benefits of TAA in optimizing portfolio returns make it a worthwhile strategy to consider.
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All posts are the opinion of the author and should not be construed as investment advice. The opinions expressed may not necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Thomas Barwick
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