Advisor Use of Tactical Allocation
April 26, 2011
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After suffering through the market crisis of 2008-2009, investors are demanding more out of their advisors. They seek downside protection in volatile markets but don’t want to sacrifice potential upside returns. Advisors have increasingly turned to tactical allocation to manage client risk. While there has been abundant discussion on how this approach should be executed in theory, we set out to determine what advisors are doing today in their practices.
Advisors burned by market volatility have chosen to supplement their strategic allocation with intermediate defections from long-term portfolio weightings. Despite persuasive academic research admonishing against market timing, advisors believe that they can identify market inflection points, navigate clients away from risk, and reallocate toward asset classes with better risk-adjusted return characteristics. This approach is based on the assumption that advisors can reliably identify which asset classes will outperform in coming periods, which is a dicey proposition at best.
Increasingly commoditized strategic asset allocation technology has also driven the shift to tactical strategies. Companies like MarketRiders provide allocation advice for as little as $10 per month. In response, some advisors are seeking to differentiate themselves by using their market knowledge and access to third-party research and to fund managers to actively monitor and run clients’ portfolios.
The question then becomes: Is tactical allocation being used to create more efficient portfolios or as a tool for sales and client retention? Our survey of Advisor Perspectives’ readers, conduced in March, provided some key insights.
Exhibit 1 |
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| Advisor Portfolio Construction Method Employed, 2011 | |||
| Source: Cerulli Associates, the Investment Management Consultants Association, and Advisor Perspectives. | |||
| Analyst Notes: Other methods included LDI, mean variance, value investing, and insured living benefits. | |||
|
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Method |
B/D |
RIAs |
All Advisors |
| Strategic allocation with a tactical overlay | 52% | 29% | 48% |
| Strategic allocation | 13% | 20% | 14% |
| Style box | 13% | 2% | 11% |
| Other | 4% | 22% | 8% |
| Tactical allocation | 4% | 12% | 6% |
| Mean variance optimization | 4% | 10% | 5% |
| Liability-driven investing or asset-liability management | 4% | 2% | 4% |
| Risk budgeting | 4% | 2% | 4% |
In Cerulli’s survey results, advisors cited using tactical allocation in one of two primary forms: some practiced unconstrained tactical allocation, while others began with a strategic allocation and supplemented it with a tactical overlay. Strategic allocation with a tactical overlay was the most frequently reported method among both broker-dealer (B/D) advisors (52%) and RIAs (29%). For these advisors, mean-variance optimization was the preferred method to establish the baseline portfolio allocations, basing decisions on historical risk and return profiles for each asset class.
The more frequent use of a constrained tactical allocation is understandable, given that B/Ds require greater homogeneity to withstand compliance oversight. Many B/Ds dictate maximum deviations from strategic allocations for each risk profile, which are continuously monitored and communicated to the home office.
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