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.

Is the Yale Model Past It?

Yale Key

It is axiomatic in the investment world that as an asset class becomes more popular, it suffers from both falling expected returns and rising correlations.  In other words, good trades get crowded and their advantages tend to disappear.  This crowding happens because success begets copycats as investors chase returns.  Mean reversion only tends to make matters worse.  In effect, it results in “investing while looking in the rearview mirror” or, as per the title of William Bernstein’s fine new book, Skating Where the Puck Was

The evidence suggests that this overcrowding is precisely what has been happening with respect to the Yale Model.  Continue reading