Tactical Asset Allocation: History, Theory & Practice Brian Schreiner Schreiner Capital...

Tactical Asset Allocation:

History, Theory & Practice

Brian SchreinerSchreiner Capital Management, Inc.Exton, PA - www.scminvest.com

June 26, 2014

2

Introduction

Two Types of Investment Strategies:

› Passive Investingor… Buy-and-Holdor… Strategic Asset Allocation

› Active Investingor… Tactical Asset Allocation

3

Agenda

› Background- What is Tactical Asset Allocation (TAA)?- How is TAA different from Strategic Asset Allocation (SAA)?

› History- TAA from the Old Testament to Today- The evolution of TAA

› Theory- Why has TAA become more popular in recent decades?- What are the potential benefits and risks of TAA?

› Practice- What are the different approaches, objectives and benchmarks?- Focus on trend following

› Q & A

4

Background

› Definitions | What is TAA?

“Tactical asset allocation (TAA) broadly refers to active strategies which seek to enhance performance by opportunistically shifting the asset mix of a portfolio in response to the changing patterns of reward available in the capital markets.”- Arnott & Fabozzi, Asset Allocation: A Handbook of Portfolio Policies, Strategies & Tactics, 1998

“Tactical asset allocation (TAA) actively adjusts a portfolio’s strategic asset allocation (SAA) based on short-term market forecasts [or trends]. Its objective is to systematically exploit inefficiencies or temporary imbalances in equilibrium values among different asset or sub-asset classes.”- Vanguard Research, 2010:

5

Background

› How is Tactical Asset Allocation (TAA) different from Strategic Asset Allocation (SAA)?

6

History

In the beginning…there were “Speculators”

1011 BC Diversification: King Solomon

FAST FORWARD 2,645 Years…

1634-1637 Market Trends: Tulip Mania in Holland

1890s Professional Money Management: The Robber Barons

1899-1902 Trend Following: Charles H. Dow

1934 Value Investing: Benjamin Graham “Security Analysis”

1930s, 40s, 50s …and beyond: Published works on many types of investing

7

History

1976 Tactical Asset Allocation: William Fouse of Wells Fargo

1980 The Information Age begins: Business Computers & PCs

1981 US stocks decline 27%

1987 Global stock markets crash

1991 The Internet: A Global Network (data as we know it)

1990s Greatest bull market in US history - TAA underperforms

2000 Tech Bubble peak (March 10)

2007-08 Financial Crisis

8

Theory

› Why use TAA?

1. Return expectations from stocks and bonds are very low over next decade.- Investors are seeking more attractive returns.

2. Stock and bonds are expensive - priced near all-time highs. - Investors want to limit exposure to risky assets.

3. Volatility has been low and will likely increase.- SAA is highly volatile - investors can reduce volatility through TAA

9

Theory

› Who is using TAA?

Everyone… - Institutions- Endowments- Pension Funds- Professionals/Family Offices- Individual Investors

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Theory

2007 2009 2011 2013

Strategic 50% 48% 65% 65%

Tactical 35% 39% 27% 22%

Other 15% 19% 8% 13%

› Percentage of RIAs who describe their overall investment approach as:

Source: AdvisorBenchmarking.com 2013

11

Theory

12

Theory: Return Expectations are Very Low

Expected return from a 60/40 stock/bond portfolio is 2.3% over the next decade.

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Theory: Stocks & Bonds Near All-Time Highs

STOCKS

BONDS

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Theory: Stock Market Volatility May Rise

CBOE Volatility Index (VIX)

15

Theory: Stocks are Expensive by Historical Standards

16Source: CrestmontResearch.com

Theory: Opportunities Exist for Active Investors

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Theory: Opportunities Exist for Active Investors

Source: Schreiner Capital Management, Inc. & Yahoo! Finance

1950 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 982000 02 04 06 08 10

2012-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

23%

17%

12%

0%

45%

29%

9%5%

38%

10%

1%

25%

1%

19%

16%

10%

2%

22%

13%

3%2%

15%17%

3% 4%

41%

21%

0%

14%

17%

32%

3%

18%

23%

3%

27%

21%

40%

15%

30%

5%

27%

6%8%

4%

36%

24%

33%

28%

20%

6%5%

3%

26%

9%

5%

15%

11%

0%

25%

13%

9%

17%

30%

0%

-3%-15% -4%-5%-16% -3%-13%-1%-28%-1%0%-5%-22%-1%

-10%-15%-25%-3%-1%-23%-38%

0%0%-16%-9%-1%-13%-19%-17%-2%-11%-2%-4%-11%-3%-1%-17% -6% -6%-2%-7%0%-3%-2%-6%-2%-15%-28%-33%-10%-5%-6%-2%-4%

-50%

-26%-9%-15%

0% 0%

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Practice

› Benchmark:TAA strategies are usually measured against a passive benchmark.

› Objective:Better-than-benchmark returns and/or Less-than-benchmark risk

› Approach: 1. Subjective

2. Quantitative

3. Combination of the two

19

Practice

› Commonly Used Quantitative TAA Strategies

1. The Fed Model Signals (Fundamental)Compares stock earning yields to bond yields to determine relative strength

2. Macroeconomic or Business-Cycle Signals (Fundamental)Measures variations in market risk premiums and firms’ earnings

3. Fundamental Valuation Signals (Fundamental)Bottom-up (firm-valuation based on dividend yield, book/market ratio, PE ratio) and/or Top-down (dividend discount model) valuation metrics.

4. Trend Following Signals (Technical)Technical analysis of market data (mostly price) to identify momentum

5. Sentiment (Technical)A contrarian approach that looks for signs of extremes (ie: consumer/investor confidence, margin borrowing)

20

Practice

› Primary Types of Trend Following:

1. Trend Line Analysis /Charting

2. Moving Average Systems

3. Relative Strength Indicators

21

Practice

› Trend Following Using Trend Line Analysis/Charting

SupportResistanceChannelsBandsFlagsCandlesticksRates of ChangeOscillatorsCloudsHeadsShoulders

…it’s endless

22

Practice

› Trend Following Using Moving Average Systems

Source: Schreiner Capital Management, Inc. For financial professional use only. This is a hypothetical example for illustration purposes only.

23

Practice

› Trend Following Using Relative Strength Indicators

Relative Strength indicators measures the change and directionof price movements.

Relative Strength = % change Industry Sector Fund

÷ % change in Benchmark

24

Practice

› Trend Following Using Relative Strength Indicators

1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 121 129 137 145 153 161 169 177 185 193 201 209 217 225 233 24120.00

25.00

30.00

35.00

40.00

45.00

25

Practice

› Trend Following Using Relative Strength Indicators

1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 121 129 137 145 153 161 169 177 185 193 201 209 217 225 233 2410.60

0.65

0.70

0.75

0.80

0.85

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Practice

› Primary Considerations for Investors

Investment Profile- Investment Personality- Investment Goals- Portfolio Profile- Risk Tolerance- Time Horizon

Due Diligence- Investment Manager(s)- Investment Vehicle- Investment Philosophy- Investment Process

Implementation- Execution Costs/Fees- Tax Implications- Opportunity Costs

27

Questions? Tactical Asset Allocation: History, Theory and Practice

Brian SchreinerSchreiner Capital Management, Inc.Exton, PA

610-524-7310bschreiner@scminvest.com

28

Sources

Arnott, Robert and Fabozzi. Asset Allocation: A Handbook of Portfolio Policies, Strategies & Tactics. Probus Publishing Co., 1998.

Faber, Mebane T. “A Quantitative Approach to Tactical Asset Allocation.” The Journal of Wealth Management. Spring 2007. Working Paper, Updated February 2009. Electronic copy available at: http://ssrn.com/abstract=962461.

Ivanova, Maya. AdvisorBenchmarking Annual Research Study. AdvisorBenchmarking.com. 2008-10.

Loeb, Gerald M. The Battle for Investment Survival. New York: John Wiley & Sons, Inc., 1935.

MacKay, Charles LL.D. Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. Mansfield Centre, CT: Martino Publishing, 2009. (First published: 1852)

Mallik, Gaurav. “Mitigating Equity Market Correlations Through Stock Selection.” SSgA Capital Insights. August, 2009.

Ostgaard, Stig. “On the Nature and Origins of Trend-Following.” December, 2008. www.lastatlantis.com.

Stockton, Kimberly A. and Shtekham, Anatoly. “A Primer on Tactical Asset Allocation Strategy Evaluation.” Vanguard Research. 2010.

Shiller, Robert J. Irrational Exuberance. Second Edition. Princeton University Press: 2005. www.irrationalexuberance.com

Wai, Lee. “Advanced Theory and Methodology of Tactical Asset Allocation.” Duke University. January 2000.