It’s important to understand tactical allocation in the context of its big sister, strategic allocation.
Strategic allocation looks at the client and their current state in the life cycle and makes allocations based on time to cash-needs (retirement, house purchase), and then lets them sit. This is what typical advisors do; it is a fire and forget approach to portfolio management. As cash needs approach, the portfolio will move to a more risk-off approach to reduce volatility before the outflow.
Tactical asset allocation starts with the same premise as strategic asset allocation and draws from the security universe that corresponds to the timeline for clients, but takes advantage of shorter-term price movements to position the portfolio for higher returns in the long term.
For example; take a tactical asset allocation based algorithm that looks at market health signals when determining a level of risk to apply to security selection for the next time period. If equity markets are up, commodity markets are relatively stable, bond markets are stable, a risk-on approach is taken and there might be a higher allocation to volatile equities that outperform.
However, in a situation where equity markets are stalling or falling, commodity markets are spiking, and bond markets are dropping (inflationary environment), our tactical asset allocation algorithm will allocate risk-off, going to low-risk equities in consumer staples, low duration bonds/bills, or commodity markets or gold to hedge against inflation.
“Winning more by losing less” is the unstated goal of TAA that seeks to take advantage of shorter-term price movements to reduce drawdown in market turbulence and increase returns in times of plenty.
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