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By Jason Stipp and John Rekenthaler | 09-11-2013 11:00 AM

Burden of Proof on Tactical Investing

To be a viable alternative to buy-and-hold, tactical funds, like the failed market-timing funds before them, must do more than claim, "It's different this time."

Jason Stipp: I'm Jason Stipp for Morningstar. On the heels of Lehman's collapse five years ago, buy-and-hold investing took a hit along with investors' portfolios, while tactical investing or market-timing strategies came to the forefront.

Here to talk about how those strategies have played out is Morningstar's vice president of research, John Rekenthaler.

John, thanks for being here.

John Rekenthaler: Thank you, Jason.

Stipp: You've been at Morningstar a long time. You've covered a lot of different kinds of funds. You've covered market-timing funds in the '80s and in the '90s. So, you have a lot of experience with these funds and their strategies and how they've played out. Give us a little bit of a history on these funds, when they've come out, and what you've learned from covering them?

Rekenthaler: To start, there aren't really any funds that call themselves "market timing" anymore in a purest sense, but these were quite popular when I started at Morningstar in 1988. Market-timing fund being defined as a fund that has an on/off switch, either they're basically in stocks, fully in stocks, or they're out of stocks, depending upon a signal that they get.

These used to be quite popular. The reason that they're not popular anymore is they universally failed, and you can't find them because it didn't work. In particular, they did operate in a tough environment for them in the 1990s, which had a long bull market, and they had too many "off " signals during the bull market, so that pretty much killed them off.

However, the cousins of market-timing funds, or I suppose you could say successors, would be funds that are now called tactical allocation, or names like that. They're not usually on/off, 100% stocks to 0% stocks. It's more nuanced than that, which gives them less room to get into trouble, but they still face some of the same issues.

Stipp: They're able to shift their portfolios, in some cases pretty dramatically, depending on where they're seeing opportunity and where they're seeing risks.

Rekenthaler: That's right. It's not just stocks or cash, which the market-timing funds were. It might be stocks, cash, bonds, various international securities. So they do a lot more than the old market-timing funds. They have much more flavor to them, or variety to them.

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