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In Practice: Tactical Strategies Miss Their Mark

Only a handful of funds are able to provide solid returns in both up and down markets.

Jeffrey Ptak, 10/25/2010

Only a handful of funds are able to provide solid returns in both up and down markets.

 "How tactical are you?"

As a registered investment advisor managing strategies for advisors and their clients, we've gotten this question a lot. Advisors want to know if we'll blow out of our investments if the market goes to pot; their clients seek reassurance that we're sufficiently "active."

Morningstar Investment Services does use tactical allocation, but in a pretty limited way--to slightly shade our target asset-class weightings based on our intermediate-term outlook. We've been skeptics of tactical strategies that make jarring moves between asset classes. In our experience, these strategies tend to have inconsistent success.

But we had never systematically analyzed that assertion--most of our encounters with tactical strategies have been on a case-by-case basis. So, we tested our assumptions and evaluated the effectiveness of tactical funds, many of which have debuted recently.

Tactical 101
Though definitions vary, tactical investing entails significant shifts between asset classes. There may not be a strategic asset allocation to moor the portfolio to a certain target mix of stocks, bonds, and alternative assets, or if there is, the tethers might be loose. For that reason, tactical portfolios can have a shape-shifting quality, reflecting changes in the manager's near-term outlook.

Time horizon can be a key differentiator of tactical strategies, which typically invest with the aim of delivering good results in varying market climates by shifting between asset classes. In fact, many tactical strategies take pains to avoid downturns, a tack that managers hope will lead to outperformance in a choppy, sideways market.

Not surprisingly, the recent market volatility has generated heightened interest in tactical allocation. The industry has taken notice: We've seen fund companies launch a raft of tactical strategies recently. As of August, nearly 50 tactically oriented mutual funds had been launched in the past two years.

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