You Can’t Outrun the Boulder

RealityBasedInvestingLogoThe idea behind tactical asset management is to make tactical shifts in asset allocation in order to take advantage of what is doing well and to escape what is doing poorly. The standard benchmark is a classic 60:40 allocation, of which VBINX is an excellent proxy. Had the whole concept of market-timing not been so utterly discredited (the latest data is here), it would probably still be called that. Such funds have broad discretion to move among stocks, bonds and cash and to move in and out of various sectors of the equity and fixed income markets in order (allegedly) to take advantage of market opportunities and to avoid market pitfalls.

From a marketing standpoint, the thrust of tactical management is to avoid market downturns (at least the significant ones) and to provide a lower volatility experience. That’s why, after almost disappearing, tactical managers returned with a vengeance after the 2008-2009 financial crisis. Visually, the idea is essentially that, like Indiana Jones, tactical managers can outrun the onrushing boulder of negative returns.

In reality, we can’t outrun the boulder, as the following video (using a plastic “boulder” – it looks like a blast) demonstrates clearly.

A Morningstar study from 2010, updated in 2012 and updated again in 2014 should put the matter to rest. During the pre-2010 period, tactical management underperformance averaged 2.6 percent per year. And over the three years through July of 2014, tactically managed funds underperformed a classic 60:40 portfolio by 3.8 percentage points per year.

The great William Bernstein states the key to that underperformance well as follows.

“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.”

Another reason for the underperformance is fees, which are the best indicator we have of performance success. Tactical funds on average charge an annual management fee of 1.48 percent as of 2014, according to Morningstar. That’s nearly double the mutual fund industry average of 0.77 percent, according to ICI.

Tactical management is yet another sort of “cargo cult” investing “solution” (thank you, Dr. Feynman) — an approach, model or system that is said to work somehow without adequate analysis, testing and safeguards. A data-mined but insufficiently authenticated “solution” will almost surely be a disaster for everyone but those collecting fees for it. Some of these “solutions” seem like a joke. Most are deadly serious. But there’s no reason to expect them to work.

You aren’t Indiana Jones. You’re not going to outrun the boulder.

14 thoughts on “You Can’t Outrun the Boulder

  1. It’s a loose analogy, but….does anyone know what the average poker player earns per round or per year? Probably pretty pathetic. So the average poker player should call it quits, agreed. Should the highly skilled poker/chess player do the same? Again, this analogy will surely suffer from some damaging counterarguments but I present it here as a thought experiment on the comparison in general, particularly the widespread focus on average skill vs. whether pursuing skill at all is a exercise in futility. Note: not a recommendation or assertion.

  2. What’s your point Seawright? Get run over by the boulder? In the long run we’re all dead? There’s nothing we can do? Just stay fully invested? VBINX has beaten the S&P 500 over the 15 year period 5.68 to 4.41 through two, TWO, market collapses, which is plenty good enough for me, but apparently not for you, and it’s CHEAP. The expense ratio is just .23.

      • Maybe if you had written the first paragraph in Latin I had understood the antecedent of “such” better than I did, and not actually confused VBINX with the type of funds you were criticizing. I felt compelled to defend it, even though I wouldn’t own it right now. Wars have been started over less, but not this time. Pax.

  3. “Market timing” can be “painted” in different ways. The odds of an investor achieving alpha by making allocation changes by acting on non-probabilistic methods ( using emotional / gut feelings or “subjective” means (technical analysis)), are most likely 50/50 at best. An investor grounding their allocation decisions on an empirical rules based framework, using statistically significant factors tested across robust time samples, has much better odds.
    Difficulty arises in that the key to discovery and invention of robust tactical allocation and risk management processes involves a virtuous circle of: 1) the acquisition of vast data series topical to economic, technical, monetary, equity metrics, etc. factors 2) the (luxury of) “time” and funding for testing and manipulating the data, and 3) aptitude and expertise in a) dissemination and elimination of resulting trial and error experimentation on / and the data series that lead to erroneous outcomes b) retention of data that leads to favorable statistical outcomes, further, to the development in the 4) aptitude and expertise ( and perhaps a little luck ) in conceptualizing / refining a “finalized” statistical multi-variable model. 5) a few years of real time portfolio management experience doesn’t hurt either. Unfortunately, money managers are not encouraged to take the “risk” of experimentation and must run in a “herd” for risk of losing their jobs. Thus, in light of this and in the attempt of dissemination of all of the media laden anecdote and hyperbole in search of genuine active management skill, no wonder why the industry, in recent years, has thrown its hands up and has succumbed to passive management and indexing !

      • Nice synopsis manager and great article Bob. Agree with you manager that an empirically based system, tested over many economic cycles, based on sound economic principles is the only way have a chance at long term timing success. You may not get it right every time, but if the process is sound, you have a good chance. Nowadays, we have pretty good access to historical economic and market data going back about 40-50 years, so a pretty good sample size for testing, but still important to recognize that today’s environment is not the same as 30 years ago; particularly with respect to interest rates and long term debt cycle. The process is still part art, part science, but with better data availability nowadays, it’s easier than ever to test new ideas.

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