Basics of Tactical Asset Allocation (TAA)
To understand the tactical distribution of assets, one must first understand the strategic distribution of assets. A portfolio manager may create an Investor Policy Statement (IPS) to map the strategic mix of assets for inclusion in the client's holdings. The manager will consider many factors such as the required rate of return, acceptable levels of risk, legal and liquidity requirements, taxes, time horizon, and the investor's unique circumstances.
The percentage of weight that each asset class has in the long run is known as Strategic Asset Allocation. This allocation is a combination of assets and weights that help the investor reach his set goals. Here is a simple example of a typical portfolio allocation and weighting of each asset class.
Cash = 10%
Bonds = 35%
Stock = 45%
Commodity = 10%
The benefit of tactical asset allocation
Tactical asset allocation is the process of taking an active stance on strategic asset allocation itself and adjusting long-term target weights for a short period to take advantage of market or economic opportunities. For example, suppose the data indicates that there will be a significant increase in demand for commodities over the next eighteen months. It would be wise for an investor to transfer more capital to that asset class to take advantage of the opportunity. While the strategic allocation of the portfolio will remain the same, then the tactical allocation may become:
Cash = 5%
Bonds = 35%
Stock = 45%
Commodity = 15%
Tactical shifts may also come under the asset class. Assume that the strategic allocation of 45% of equity consists of 30% of large capitals and 15% of small capitals. If the outlook for small cap stocks does not seem favorable, it may be a wise tactical decision to shift the in-equity allocation to 40% for large capital and 5% for small capital for a short period until conditions change.
Typically, tactical shifts range from 5% to 10%, although it may be less. In practice, it is unusual for any asset class to be adjusted by more than 10% tactically. This major adjustment will present a fundamental problem in constructing the strategic allocation of assets.
Tactical asset allocation differs from portfolio rebalancing. During rebalancing, trades are made to return the portfolio to the required strategic asset allocation. Tactical asset allocation adjusts the strategic allocation of assets for a short period, with the goal of reverting to strategic allocation once short-term opportunities disappear.
The main gaps
Tactical asset allocation involves taking an active stance on strategic asset allocation itself and adjusting long-term target weights for a short period to take advantage of market or economic opportunities.
Tactical shifts may also come under the asset class.
In a discretionary TAA, the investor adjusts the asset allocation, according to the market's assessment of changes in the same market as the investment.
Types of tactical asset allocation
TAA strategies may be discretionary or methodological. In a discretionary TAA, the investor adjusts the asset allocation, according to the market's assessment of changes in the same market as the investment. An investor who holds large stocks, for example, may want to reduce these holdings if bonds are expected to outperform stocks for a while. Unlike stock picking, tactical asset allocation involves judgments about entire markets or sectors. Thus, some investors see TAA as complementary to mutual fund investing.
Conversely, the TACS uses a quantitative investment model to take advantage of shortcomings or temporary imbalances between different asset classes. These shifts use a foundation of known financial market anomalies, or incompetence, backed by academic and practitioner research.
https://www.gold-pattern.com/enReal world example
It found that 46 percent of respondents in a survey of small hedge funds, endowments, and foundations use tactical asset allocation techniques to beat the market by riding market trends.