Buying Umbrellas After the Storm

Investors have been telling their advisors that they must have protection from the next 2008-type scenario every day since, well, 2008.

And of course, this demand is not unreasonable – no one wants to see their retirement portfolio cut in half again for the third time in fifteen years.

So as a result, tactical mutual funds, once an obscure corner of the industry, have seen their assets under management quadruple since 2007. Everyone wants to buy an umbrella once it’s already rained, just like half of my town on Long Island raced to equip their homes with generators in the months following Hurricane Sandy. “I’m not going through that shit again.”

Unfortunately, investors (and their advisors) are now finding out that there is a price to be paid, a cost for this tactical “insurance” being added to the mix: In a bull market, it can easily be a drag. And if you pick a really poor manager, or a quantitative strategy with signals that no longer work, it can actually lose you money. And, even if they work great, they can be expensive (turnover, taxes, internal fees, sales loads) – more expensive, sometimes, than the drawdowns they claim to be protecting you from.

No free lunch, same as it ever was.

Here’s Daisy Maxey at the Wall Street Journal on the phenomenon:

There are 41 mutual funds with “tactical” in their names that are tracked by investment-research firm Morningstar Inc., including 18 that were launched since the beginning of 2012. Total assets in this fund category have risen to $4.92 billion from $1.10 billion in December 2007, according to Morningstar.

Just as the so-called market-timing funds did years ago, the tactical funds are underperforming balanced portfolios: On average, they gained 6.9% over 12 months and 7.7% annually over three years through Aug. 31. A classically balanced, passively managed portfolio–with 60% invested in the S&P 500 index and 40% invested in the Barclays U.S. Aggregate Bond Index–would have gained 10.2% and 12.1%, respectively, in the same periods, Morningstar said.

With tactical funds now adding more drag than performance over the three year period relative to the most vanilla benchmarks available, I fully expect to see the trend toward tactical strategies on the wane in the coming year. And then, just when they’re needed most, no one will own them 😉

Rinse and repeat.


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