Investment strategies

Tactical Asset Allocation - How and when to rebalance risks and profits

November 14, 2022
3 min

Financial markets are like the metaphor of the half-full or half-empty glass. As a result, fluctuations scare some investors who adopt conservative approaches to secure their capital. 

Others believe timing and mastery are the right tactic to stay afloat in the churning sea of market volatility and — like surfers — try to ride the momentum wave.

So, instead of prudently waiting for the waters to subside, they approach trading actively and dynamically.

What’s Tactical Asset Allocation?

Tactical asset allocation (TAA) is an active investment strategy. The asset mix is adjusted, so the portfolio's risk level, liquidity, or return rate remains stable despite market volatility.

Tactical Asset Allocation can be discretionary - based on collecting market insights on an individual level - or systematic - following pre-established patterns (such as mathematical models or software analysis).

How Does Tactical Allocation Work?

When investing, portfolio managers try to ensure the assets purchased to align with risk appetite and desired returns.

This way, they aim to achieve a balanced asset mix.

Where active portfolio management differs from those who opt for strategic investment is the belief that, over time, this balance is ensured by adapting to market cycles rather than keeping the initial allocation unchanged.

Strategic vs. Tactical Asset Allocation

Although the approach is opposed to buy-and-hold, the intent is to keep the portfolio balanced.

Those who opt for tactical allocation believe the market offers price inefficiencies that can be exploited or represent a threat. In this case, active portfolio management can boost or preserve performance without considerable risk increases.

In contrast, those who support the efficient-market hypothesis think relying on human abilities to spot market vulnerabilities is a mere illusion, as the price of securities corresponds to the information available.

Another critical aspect of the debate concerns market timing. This is a determining factor in both cases. A potential weakness in strategic asset allocation can lie in entering (or planning to exit) at the wrong time, severely compromising portfolio performance.

Tactical asset allocation supporters have on their side the ability to reduce exposure to systemic market risk by rebalancing the portfolio dynamically. This step is also influenced by the timing with which it occurs.

Additionally, more frequent operations expose the trader to higher investment fees.

Some are highly critical of tactical asset allocation, such as Larry Swedroe, who considers it an excuse that some portfolio managers use to pocket more commissions.

Others, such as Morningstar, Inc., opted for a less ideological approach. According to a study conducted between July 31, 2010, and December 31, 2011 (later updated to 2013) on 163 tactical asset allocation funds, only 20% beat the Vanguard Balanced Index Fund, and only four provided a better shape ratio.

  • Tactical asset allocation advocates may argue skills are the determining factor and that 20% of funds is evidence of this;
  • Critics, on the other hand, would say in such a short timeframe, 20% is nothing but the result of favorable but fortuitous conditions (a statement also supported by the only 4% with a better shape ratio), and in the long run, strategic asset allocation guarantees better performance.

Who’s right?

Our position is the best of choices and the totality of circumstances are determining factors (and the latter is only sometimes easy to manage in advance).

The need to monitor the market closely and the ability to anticipate its movements make this approach unfeasible for rookies who better look for an expert advisor.

Assets vs. Asset Classes

Those who operate tactically usually emphasize asset classes more than single assets.

That's because the overall response of certain asset classes to particular market conditions is predictable, and diversification of individual assets can mitigate the overall class risk.

Peccala’s Algorithmic Tactical Allocation

Peccala balances his derivatives on an hourly basis, looking for patterns for both long and short positions. The absence of a market operator qualifies Peccala's asset allocation as Systematic.

Peccala's algorithmic trading has two advantages for investors, especially novices:

1- Decisions are not influenced by emotion or the quality of the sources of information (as can happen in discretionary trading).

2- From the investor's point of view, the transaction is no more complicated than the classic buy-and-hold. The investor only has to buy the desired amount of Peccala Tokens (choosing between the high-risk strategy or the medium-risk strategy), and the algorithm will take care of trading the derivatives on the major exchanges on its own. The value created by these trades will be reflected by the value of the token (according to the following formula).

Peccala Token Price Formula = Net Asset Value / Number of token in circulation

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