Tactical asset allocation

Tactical asset allocation is an active investment strategy that adjusts a portfolio's asset class weightings according to short term forecasts of expected returns. The strategy is often considered a moderate active strategy, since managers usually return to the portfolio's original strategic asset mix when desired short-term profits are achieved. . Many asset allocation mutual funds are designed to use tactical asset allocation strategies.

Common tactical asset allocation strategies
According to a Vanguard paper, "A primer on tactical asset allocation strategy evaluation", practitioners of tactical asset allocation primarily utilize one or more of the following approaches, using various signals and valuation metrics, in setting tactical asset allocation weights for asset classes.


 *  The “Fed model” signals: This model compares stock earnings yields (the inverse of the price/earnings [P/E] ratio) to nominal bond yields to to set allocation weights. Clifford Asness (2003) detailed several drawbacks to this approach.
 * Business-cycle/macroeconomic signals: Signals include term spreads (the yield differential between long- and short term bonds), the credit spread (the yield differential between high- and low-credit-rated corporate bonds), “unexpected inflation,” and industrial production.
 * Fundamental-valuation signals: Metrics include dividend yield, book/market ratio, and P/E ratio, to determine relative valuation. Another approach is to use the dividend discount model to determine the required rate of return from market prices and projected dividend growth rates.
 * Momentum signals: Signals include technical indicators, earnings growth, and changes in trading volumes.
 * Sentiment signals: Signals include measures of consumer confidence and margin borrowing.

Vanguard tactical asset allocation funds
The Vanguard series of Managed Payout Distribution funds employ a tactical asset allocation strategy, currently allocated across the following asset class funds:


 * Vanguard Total Stock Market Index Fund Investor Shares
 * Vanguard Intermediate-Term Investment-Grade Fund Investor Shares
 * Vanguard Market Neutral Fund Investor Shares
 * Vanguard Total International Stock Index Fund Investor Shares
 * Vanguard REIT Index Fund Investor Shares
 * Vanguard Total Bond Market II Index Fund Investor Shares
 * Commodities (The fund invests a portion of its assets in commodities through the use of swap contracts)

The tactical asset allocation strategy is described in the prospectus, as follows: Asset allocation—that is, dividing your investment among stocks, bonds, cash, and other asset classes or investments—is one of the most critical decisions you can make as an investor. Each Managed Payout Fund invests in Vanguard mutual funds and other potential investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. The advisor uses quantitative analysis and professional judgment in an attempt to combine complementary asset classes and investments across the risk/reward spectrum. The advisor’s goal for each Fund is to construct a broadly diversified portfolio that achieves the Fund’s investment objective. The advisor has appointed an investment committee for the Funds. The investment committee makes three key asset allocation decisions for the Funds. First, the committee identifies eligible asset classes and investments for each Fund. Second, the committee establishes strategic asset allocation ranges specifying the Funds’ minimum and maximum long-term allocations to eligible asset classes and investments. Third, the committee establishes a short- to intermediate-term asset allocation target for each Fund. The committee’s asset allocation targets govern the portfolio manager’s day-to-day investment decisions for each Fund. The investment committee’s decisions are based, in part, on a consideration of a wide range of strategic inputs, which may include some combination of the following factors (or others): the Funds’ prior performance; value at risk and expected shortfall; volatility; macroeconomic factors; current and expected market conditions; cash flows; estimates of changes in the spreads between the expected returns of eligible asset classes and investments; historical and expected correlations between and among asset classes and investments; quantitative modeling of the likelihood that a proposed combination of asset classes and investments will achieve a Fund’s investment objective; and the results of stress tests. The investment committee’s decisions are also based on the collective professional judgment of its members. The Funds are managed in accordance with a variety of statistical and compliance-based risk management controls and procedures. The Funds do not have fixed asset allocations but have the flexibility, subject to applicable law, to invest substantially in a single asset class or investment. However, the Funds are generally expected to invest their assets across multiple asset classes or investments. The assets of each Fund are independently allocated based on the Fund’s investment objective. The exact proportion of each asset class or investment held by a Fund may change to reflect shifts in the advisor’s risk-and-return expectations.

Historically, Vanguard ran an asset allocation fund (Vanguard Asset Allocation Fund) that employed a tactical asset allocation policy in managing its portfolio allocations. The fund existed from its inception in 1987 until its merger into the Vanguard Balanced Index Fund in 2012. The fund was a long time component of the Vanguard series of LifeStrategy funds of funds, which included the fund in its allocations from inception through 2011. Historical data on the Asset Allocation Fund can be found at Vanguard Asset Allocation Fund Tax Distributions.