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Tactical-Allocation Funds: Even Worse Than Expected

They were never going to be good ... but this bad?

John Rekenthaler, 08/30/2016

Fool Me Once
Tactical-allocation funds--investments that readily adjust their asset mixes in response to current market conditions--are a sucker’s play.

Such funds garner assets after a stock market crash, preying on investors’ desires to win the previous war. That war fails to arrive; tactical-allocation funds lag the rising markets; their shareholders become disillusioned and exit the funds. A few years later, that next stock market crash does arrive. The tactical-allocation funds then become paper tigers, showing strong relative performance but offering little benefit to investors given their small size.

I watched that process occur in the late '80s and early '90s, after the October 1987 collapse, so I was under no illusion when tactical-allocation funds returned to popularity in 2009. Give the portfolio managers their freedom, check. Untie them from the tyranny of benchmarks, check. Let active managers truly be active, check. All the appropriate boxes were ticked. The category was poised to fail.

Foolish Consistency
And fail the category has, most spectacularly. Earlier this month, in Advisor Perspectives, guest author Luke Delorme examined the category’s trailing five-year returns. The results were breathtakingly bad. Among the 57 tactical-allocation funds, "not a single one of them outperformed the simple, low-cost, passive fund" of Vanguard Balanced Index VBIAX. "One would think, by chance alone, that at least one of these funds would outperform. But no, their performance has been universally lousy."

Shrinking the analysis to three years makes no difference to the result; every tactical-allocation fund trailed. Increasing the analysis to a decade, ditto. The same holds true for 15 years. You name the time period, tactical-allocation funds missed the boat. True, Delorme did find that two of the funds were better than Vanguard’s passive offering if measured on risk/return (rather than return alone) over the 10-year period. But none were better over three years, or five years, or 15 years.

Another View
Two questions arise. One: Is the problem unique to tactical-allocation funds? Perhaps other flavors of allocation funds have been similarly poor, in which case the criticism should be expanded. Two: Is the comparison to Vanguard Balanced Index fair? That fund may be rather different in construction than the typical tactical-allocation fund.

The answer to the first question: Yes, the problem is unique.

To be sure, Vanguard Balanced has been a resounding success by any standard of allocation fund. Within the allocation--50% to 70% equity Morningstar Category (an awkward label, but certainly descriptive), the Vanguard fund has easily beaten the group averages. What’s more, while Vanguard Balanced does trail several of its own category’s funds over all time periods--typical of passive offerings, which tend to be reliably good rather than number-one winners--it has trounced all funds in the target-date 2020 category. As with the tactical-allocation group, all target-date 2020 funds have lagged Vanguard Balanced over the three-, five-, 10-, and 15-year periods.

is vice president of research for Morningstar.

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