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By Christine Benz | 09-27-2010 05:53 PM

Kinniry: Data Doesn't Bear Out a Tactical Approach

Investors may be well-served by tactically tweaking their broad allocations in extreme times, but wholesale tactical strategies have not generally performed well, says Fran Kinniry of Vanguard's Investment Strategy Group.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

In the wake of the bear market, a lot of investors have begun to embrace more tactical approaches rather than using the strategic buy-and-hold approach to asset allocation.

Here to discuss the two strategies is Fran Kinniry; he is principal in Vanguard Investment Strategy Group.

Fran, thanks for joining us today.

Fran Kinniry: Thank you, Christine.

Benz: So tactical is the big buzz word I hear from a lot of our users. A lot of them are saying buy and hold is dead; it did not serve me well during the bear market. Where do you come down on that question and how to arrive at the right approach for an investor?

Kinniry: I think whenever we have market extremes, which we've really experienced, we're down 55%, up 70%. The theory or the logic behind tactical makes a lot of sense, but I think you have to really go under the covers and say, can it work or has it worked?

When you look at cash flow data, there was huge positive cash flows in front of the bear market, which means that people were not backing away from the equity market, and the vast majority of investors missed this 70% runup because we've seen negative cash flows from the bottom.

So in theory, extreme markets lead one to say buy and hold is dead or I could be more tactical. When we look at the data, and we look at the asset allocation funds that are out there, including on Morningstar, they have not performed all that well.

Benz: Our research certainly bears that out. But the tactical umbrella has a lot of different strategies beneath it, and I'm wondering are there any strategies that make more sense to you than others within the tactical realm.

Kinniry: We've looked at it, long and hard. And actually, we have a real reason to look at this and spend a lot of time looking at it, and really the only thing we've found that has some merit is at the stock/bond mix, meaning we don't see a lot between U.S. and international or growth and value or size, but we do see some ability of tactical allocation in the extremes and really the extremes are limited periods in time where this occurs. So, 1998-1999, when you saw a valuations at unprecedented levels, one could have said the equity market was set up for potentially lower returns, and in 2009, believe it or not, at the bottom, the equity market looked about as attractive as it had in 20 to 25-plus years.

And so there is a lot of noise in the middle, but there are some small windows in time where the stock/bond mix, you may want to shade, and we would say only small shades if you were 60/40 stock/bonds, maybe it would go up 5% or 10% in your equities or down 5% or 10%, but really never making wholesale moves.

Benz: And arguably a rebalancing strategy would kind of get you there.

Kinniry: Absolutely, a rebalancing strategy is probably the best way to take advantage of some of these opportunities without making wholesale changes; that's exactly right.

Benz: So, Fran, you have a lot of index-based products under the Vanguard umbrella, and my question is, is there a concern that advisors and individual investors are using some of these funds to employ tactical approaches and maybe doing themselves a disservice in doing so?

Kinniry: We don't see that happening all that much. I mean advisors have embraced low-cost investing, which I think is great for investors. You can see the cash flow going into index funds and into ETFs, which is a dominant theme of the last decade, and they could have done the same tactical strategies quite frankly in traditional index funds that they did in ETF. So, we don't think the evolution or the adoption of ETFs has led to any different behaviors as it relates to the advisor community.

Benz: Okay. Well, thanks, Fran. Thanks for sharing your insights. We appreciate it.

Kinniry: Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

 

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