Have tactical asset allocation funds earned their keep?


The Perfect Storm

This year provided the perfect climate for tactical allocation funds. Unlike strategic allocation funds, which maintain their positions through thick and thin, tactical funds hope to avoid bear markets. They cannot anticipate sudden onset losses, such as those that chaperoned the arrival of the novel coronavirus. But when investment problems are telegraphed, as with losses caused by Federal Reserve interest rate hikes, tactical funds should excel.

Tactical funds desperately need a win. The decade leading up to this year’s turmoil was unusually quiet, with steady gains in stock and bond markets punctuated by brief declines in late 2018 and early 2020. That’s great for investors, but unpleasant for tactical funds. Lacking opportunities to show their footsteps, while also burdened with their higher costs – like an extra pizza topping, the tactical allowance isn’t free – the group lagged their rivals badly.

The proof is below. The graph illustrates the 10-year returns, up to last December, for several categories of allocation funds. The closer to the northwest corner of the chart, the better the category’s performance. Unfortunately, the light blue dot that represents tactical funds lands somewhere near the Mississippi.

Total return and standard deviation over 10 years – source: Morningstar analysts

Consider survival

As measured by volatility, the closest competitor to tactical funds was the allocation – 50% to 70% Morningstar Category stocks. Over the decade, these funds outperformed their tactical rivals by 3 percentage points per year. After adjusting for the lower volatility of tactical funds and higher expenses, the deficit becomes 2 percentage points. This amount represents the average annualized loss of tactical fund transactions. For tactical funds, less would have meant more!

In fairness, this margin could be affected by survival bias, as the calculation excludes funds that expired between 2012 and 2021. Tactical funds may have existed throughout the decade, while their competitors were going and came. If so, the study will have treated tactical funds unfairly, counting all of their results while neglecting some of their competitors. The following exposition tests this hypothesis. It shows the percentage of funds in each category that survived the 10-year period.

The percentage of tactical funds in each category that survived the 2012-2022 period.  Tactical funds were more likely to disappear than other allocation funds.Percentage of surviving funds (July 2012-June 2022) – source: Morningstar analysts

Oh dear. The tactical funds were After likely to disappear than other allocation funds, no less. Given that most mutual funds are scrapped due to poor performance – companies regularly shut down 1-star offerings but rarely their 5-star siblings – the numbers imply that tactical funds have done even worse than suggested. numbers.

This year’s model

They may not have recovered all that shortfall in 2022, but they may have made some significant inroads. Below is the average year-to-date total return for tactical allocation funds, as well as that of its closest competitor, the 50%-70% equity class.

Average total return year-to-date for tactical allocation funds, as well as that of its closest competitor, the 50%-70% allocation share class.  The two groups behaved almost identically.Year-to-date total return for tactical allocation funds, as well as that of its closest competitor, the 50%-70% allocation share class. – source: Morningstar Analysts

You don’t have to read the fine print to understand the lesson: as the lengths of the two bars demonstrate, the two groups behaved almost identically. Through June, tactical funds had lost 14.4%, with their strategic competitors a little behind, losing 14.5%. At this rate of closure, tactical funds will fully regain their lost territory in… [checks spreadsheet] the year 2145. More or less.

Does the performance persist?

There is one last chance to redeem the tactical allocation funds. As proponents of active management often say, shareholders own individual funds, not classes of investment. For those who hold the best funds within a category, the aggregate amounts are irrelevant. After all, several tactical funds have made outright profits this year, and several others have landed only slightly in the red.

The question is whether shareholders can identify these funds before the fact. A simple but useful test is to see if this year’s results match those of the previous decade. Did the winners of 2022 also succeed from 2012 to 2021? If so, investors may have spotted them ahead of time. However, if their 10-year returns weren’t particularly strong, it’s unlikely that many shareholders would have recognized the opportunity. For better or worse, most active management reviews include a healthy dose of past performance.

I tested this proposition by comparing the total return rankings of tactical allocation funds over the 2012-21 period with year-to-date rankings. To cite one example, Astor Sector Allocation Fund ranked third out of 41 tactical allocation applicants over the past decade. This year, he is in 29th place. In this case, at least, past performance did not provide a useful indicator for future results. But it may be that with other funds the result was different.

It was not. This final exhibition retraces the two series of rankings.

Total return rankings for tactical allocation funds over the period 2012-21 with year-to-date rankings.  There is a correlation of -0.35.Total return rankings for tactical allocation funds over the period 2012-2021 with year-to-date rankings. – source: Morningstar Analysts

A model exists. The dots have a weak but noticeable trend from the top left corner to the bottom right corner. Unfortunately, it’s the Wrong effect. If relative performance were persistent, with stronger funds remaining superior, the points would rise to the right. Instead, the opposite happened. In general, the tactical allocation funds that had the highest 10-year returns in 2022 fell the most. Meanwhile, the erstwhile laggards have led.

In summary, investors had little, if any, chance of picking the winners of this year’s tactical funds. Perhaps they could have identified the more cautious funds, thinking that the Fed’s interest rate hikes would cause a bear market. But anyone who knew this in advance should not buy a tactical allocation fund. They should be manager a.


Regular readers of this column will know that, in general, I prefer simple, cheap funds to their more expensive, more ambitious rivals. History is on the side of the former. However, I will gladly acknowledge exceptions to the rule, if they appear. (I’ll gladly do that, because exceptions are interesting.) Recent events have given tactical allocation funds that chance. Unfortunately, they escaped the ball. I see no reason to invest in such funds.


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