Tactical asset allocation

From Bogleheads

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 moderately active strategy, because managers usually return to the portfolio's original strategic asset mix when it has achieved short-term profits.[1] Many asset allocation mutual funds use tactical asset allocation.

Common tactical asset allocation strategies

According to a Vanguard paper,[2] most tactical asset allocation uses one or more of the following approaches. All of them use various signals and valuation metrics to set 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 detailed several drawbacks to this approach.[3]
  • 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

Vanguard has historically used tactical asset allocation for a limited number of its balanced funds.

Vanguard Managed Payout Distribution Fund

The Vanguard Managed Payout Distribution Fund employs a tactical asset allocation strategy. The fund is allocated across the following asset class funds, as of December 2014:

  • Vanguard Total Stock Market Index Fund Investor Shares
  • Vanguard Global Minimum Volatility Fund Investor Shares
  • Vanguard Market Neutral Fund Investor Shares
  • Vanguard Total International Stock Index Fund Investor Shares
  • Vanguard Total International Bond Index Fund Investor Shares
  • Vanguard Emerging Markets Stock 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)

An investment committee directs the fund's tactical asset allocation strategy. It makes three key asset allocation decisions:[4]

  • Identify eligible asset classes and investments for the fund;
  • Establish strategic asset allocation ranges specifying the fund's minimum and maximum long-term allocations to eligible asset classes and investments;
  • Establishes a short- to intermediate-term asset allocation target for the Fund. The committee’s asset allocation targets govern the portfolio manager’s day-to-day investment decisions for the fund.

The decision making process includes the following tactical strategies:[4]

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 Fund’s 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.

Vanguard Asset Allocation Fund

Historically, Vanguard ran an asset allocation fund (Vanguard Asset Allocation Fund) that used tactical asset allocation to manage its portfolio allocations. These consisted of varying allocations to an indexed stock portfolio tracking the S&P 500 index, to long-term treasury bonds, and to treasury bills. The fund existed from 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.

See also

References

  1. "Tactical Asset Allocation - TAA". Investopedia. Retrieved August 10, 2023.
  2. "A primer on tactical asset allocation strategy evaluation" (PDF). Vanguard Group. 2006. Archived from the original (PDF) on January 22, 2019. Retrieved August 10, 2023.
  3. Clifford Asness (2002). "Fight the Fed Model: The Relationship Between Stock Market Yields, Bond Market Yields, and Future Returns". Retrieved August 10, 2023. Available at SSRN
  4. 4.0 4.1 "VANGUARD VALLEY FORGE FUNDS Prospectus". 2014. p. 18. Retrieved August 10, 2023.

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