How to Pick a Tactical Manager?
Tactical asset allocation (TAA) has come back in fashion recently. Investors were stung, badly, by the financial crisis of 2008. No one wants to go through an experience like that again, which has led to renewed interest in TAA. A new group of tactical managers called ETF strategists has emerged to meet the demand from investment advisors and investors. ETF strategists normally use ETFs heavily to make their tactical bets. According to Morningstar, there were 660 ETF strategies from 151 firms with $103 billion asset under management as of Q1, 2014.
TAA is nothing new and has been around for decades. Its objective is simple: a tactical manager has the flexibility to move quickly among different asset classes so the manager can participate in market upside while limiting the downside risks. Instead of picking the best stocks like traditional mutual fund managers, tactical managers are trying to identify the best time to get in and out of broad asset classes like stocks and bonds based on some black-box algorithm or fundamental judgment.
Market timing is not an easy task. In 1994, John R. Graham and Campbell R. Harvey published a research paper analyzing the market-timing ability from newsletters. ” We analyze the advice contained in a sample of 237 investment letters over the 1980-1992 period. Each newsletter recommends a mix of equity and cash. We construct portfolios based on these recommendations and find that only a small number of the newsletters appear to have higher average returns than a buy-and-hold portfolio constructed to have the same variance.”
Some of the ETF strategists did deliver some degrees of downside protection in the last decade during the last two bear markets. However, the recent performance of some big tactical ETF managers has been disappointing. Investors have started to realize that not all tactical managers are the same. Picking a good tactical manager is the key to investment success. As a tactical asset manager ourselves, we like to offer some insiders’ advice to investors as follows:
(5) Sales organization vs. research organization
Some asset management firms build successful businesses with extensive sales efforts even though their investment performance is mediocre. Investors should try to avoid those firms, and instead invest with the firms who allocate more resources to research and portfolio management. In the end, it is the in-depth research capability that will help a tactical manager to deliver superior returns in the long run.