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Larry Swedroe on the Failure of Tactical Asset Allocation Funds

Not many people can truly do tactical asset allocation (TAA) correctly.  Because it’s hard.  Oftentimes prospective new clients will come to us and complain that their discount brokerage-recommended advisor is too plain vanilla and never sells or gets tactical.  I explain to them that this is a good thing – because the last thing they should want is a traditional FA trying to trade the market for them.  They simply aren’t equipped with the tools, signals and know-how to do so on a regular basis.

The twelve-year secular bear market has allowed for a flourishing of TAA mutual funds as investors have given up on buy-n-hold in droves.  The problem is, these funds aren’t doing them any favors favors either.  Notorious active management skeptic Larry Swedroe shows us some astonishing facts via a Morningstar research report on tactical asset allocation funds;

In its most recent issue of “Morningstar Advisor,” the investment researcher updated an earlier study on TAA funds that showed that 70 percent of funds underperformed the Vanguard Balanced Index Fund (VBINX). Did the rough markets we saw last year give TAA funds a chance to redeem themselves? Apparently not. Again using VBINX as the benchmark, Morningstar found:

  • Very few TAA funds generated better risk-adjusted returns than VBINX.
  • Just nine of the 112 TAA funds in existence over the period August 2010-December 2011 had higher Sharpe ratios (a measure of risk-adjusted returns).
  • Only 27 funds experienced smaller peak-to-trough declines than VBINX.
  • Only 14 of the 81 tactical funds in existence since October 2007 posted lower maximum drawdowns during the 2008 financial crisis, the spring/summer 2010 correction, and the recent European debt-related downtown. Put another way, just 17 percent of them consistently provided the insurance investors were paying for.
  • In a simulation of various hypothetical portfolios over the 10-year period ending December 2011, the average TAA fund would have provided very little in the way of incremental diversification.

Bottom line: TAA fund investors incurred heavy fees because of the active management, and returns were poor. In short, we have another game where the winners are product purveyors, not investors.

The lesson here is that just because someone claims to be tactical, it doesn’t mean they’re any good at it.

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