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Zweig: Tactical Asset Allocation Has a Lot to Prove

Christine Benz

Christine Benz: Hi. I'm Christine Benz for Morningstar.com. I'm here today in the Wall Street Journal's office and I'm joined today by Jason Zweig. Jason is a personal finance columnist for the Journal, and he's also author of several books about money and investing.

Jason, thanks so much for being here with us today.

Jason Zweig: Glad to have you, Christine.

Benz: So Jason, I'd like to talk about tactical asset allocation, which seems like it's gaining evermore traction in the marketplace. Investors are really interested in this idea of being able to jump in and out of various asset classes. I'd liked your take on that strategy versus one that is more long-term and strategic and hands off.

Zweig: Yes. It's really a difficult question, Christine. The frustration of both individual investors and professional investors after the past 10 years of agony, I guess, we should call it, is really, really high. And it's completely understandable; people have thrown their hands up. They say, buy and hold doesn't work. The whole "stocks for the long run" thing isn't working for me anymore.

So I'm going to do something different, and I'm going to take control. The problem is while you may have taken control of the actions in your portfolio or you may have taken control of your portfolio, you can't take control of the markets. And you may have an intuition that right now is a really good time to be trading foreign currencies, and you run out and buy Swiss francs or sell Japanese yen or vice versa or Norwegian kroner or whatever floats your currency boat, thinking that I failed over here, so I'm going to succeed over here.

But it's very important for people to realize that there just aren't any free lunches anywhere, and just as strategic long-term asset allocation isn't going to work all the time, there's no particular reason why tactical asset allocation would have a higher success rate.

In fact, common sense would tell you that if you didn't do so well when you were making a small number of decisions, going to a system in which you're going to make a large number of decisions and expecting that you'll be right more often probably isn't the best way to think about it.

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So I think it very much remains to be proven whether tactical asset allocation is or even can be more effective, not just for individual investors, but for professionals.

There are tactical asset allocation mutual funds that have been around for a long, long time. There are also many more that no longer exist because they were closed down, because the people with multimillion dollar budgets and supercomputers, and the world's best investing software failed at it. So I don't think that the average investor is likely to succeed at it, and I'm really not persuaded that most professionals will either.

Benz: Another question is regarding global diversification in the context of asset allocation, and I know that you're an indexing enthusiast, and I wondered if that thought process extends to global diversification. So should you just look at a cap-weighted global index and set your foreign stock versus U.S. stock weightings according to that? How would you suggest that investors proceed?

Zweig: The classic advice has always been something like this: If you are a U.S based individual investor, you should have 10% to 30% of your stock assets invested outside the U.S. No one ever really has explained why that is. There are so many rules of thumb in investing that center on 10%. You should have 10% of your money in this and you should do 10% of – spend 10% of your time on that. No one ever – 10 is kind of a magic number, right.

I would start from a different premise, which is I would say, if I were a little green man on Mars or a little green woman, and I wanted to buy the whole planet, I wanted to be an equity investor on planet earth, and I beamed my dollars down, where would they all land, and the answer of course is, what you just called the global cap-weighted portfolio, where, roughly depending on the month, 40% to 50% of your money would be in the U.S., and 40% to 50%, 50% to 60% would be outside the U.S. So, I would take that as my starting point.

It's not that, you must have half of your money outside the U.S, but rather if you have much less, you should be asking yourself, why? Do I work for a company like Coca-Cola that earns the vast majority of its revenues and income outside the U.S, then it might make sense for me to have less of my money abroad. But if I work for, I don't know – an air conditioning distributor in Atlanta, that earns virtually all of its money in the U.S., then maybe I should have more of my money outside, so that I'm naturally hedged against the American economy.

Benz: Also wanted to ask about commodities. The commodities became sort of a must-have asset in portfolios maybe three years ago. Now it seems that a lot of professionals are kind of questioning whether at least the futures-based commodity products were maybe not ready for primetime. What's your take on that asset class in the typical investor's portfolio?

Zweig: This is something I wrestle with a lot. I own no commodities whatsoever anywhere in my portfolio, and historically, I have been quite happy not to have. I have taken a lot of heat from various people for that over the years, and I'm not planning to make a change anytime soon.

I think, there are good arguments on both sides, but the argument I keep coming back to in my own head is, it's really only in the last 10 years that commodities have actually been an investment asset at all.

Historically, there were two groups of people, who bought – well, there were three. There were two main groups and small third group. They were the producers of commodities, say Exxon or Newmont Mining, a gold company, and they wanted to hedge their risk that the price of what they dig out of the ground and sell would go down.

The second category was the consumers. So, a pharmaceutical company, for example, that buys a lot of oil was hedging the risk that the commodity price would go up. And then there was a third group, much smaller, which was the traders or speculators.

What's happened in the past few years is the commodities are now regarded as an investment and now the vast majority of the money coming into that market is coming from people buying commodities for investment purposes, which is a completely new development. And it's hard for me to believe that that's sustainable in the long run and that the returns going forward will remain attractive now that the marginal dollar going into commodities is coming from people who expect to get an investing return on that dollar, and that just didn't exist before. And I think that situation probably will not last indefinitely.

Benz: Okay. Thanks for sharing your insights. We appreciate it, Jason.

Zweig: Thanks, Christine.

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