So if the academic, Strategic approach is so great, why do we also utilize a Tactical approach? Well, while we agree with much of the research on passive investing, we are not believers in the so called strong version of the efficient market hypothesis. We do not believe that markets are always priced efficiently and that investors always act rationally. We readily acknowledge that active portfolio management is difficult and that the strategic approach offers some advantages, but we also cannot ignore the simple fact that markets do not always act as the textbooks say they should.
Any investor who witnessed the bubble years up close knows that “investors” do not always act rationally. Stocks in 1999 were overvalued by any historical measure and as they say, it is never different this time. A reversion to the mean was a no brainer, although getting the timing right was no easy task. The problem with a purely strategic approach is that it would have ignored the obvious overvaluation and allocated the same percentage to stocks as it would at any other time and valuation. Frankly, we think investing without regard to valuation borders on malpractice in a business where we are supposed to act as a prudent man would. Buying internet stocks or even most broad market indexes in late 1999 was not a prudent act.
Having said that, no valuation technique is perfect and we continue to use the strategic approach because we readily acknowledge that our judgments about value may be mistaken from time to time. (and, of course, because over very long periods of time, it does work).Error free investing is impossible but we tend to focus on valuation extremes so our errors are usually ones of timing rather than direction. Markets can and do rise and fall more than fundamental analysis would predict. Investors can and do remain irrational for long periods of time. That is true in markets that are falling as well as those that are rising. So while our timing may sometimes be imperfect, we believe that a focus on fundamentals is critical to avoiding capital losses. And it is what a prudent man would do. The Tactical approach complements the Strategic approach and allows us to adjust portfolios in a prudent way when markets are acting irrationally.
Our Tactical Portfolios range from ETF-based trend-following models to all-stock or all-bond model portfolios that are actively managed. While we tend to use the same asset classes as are found in our Strategic Portfolios, the allocation to each asset class is adjusted using a top-down approach based on our economic outlook, as well as fundamental and technical analysis. The Tactical Portfolios are global in nature, but do not have specific geographic allocation requirements. Our Tactical Investing Process is as follows:
From this process we derive the Tactical Portfolios. Here is a brief description of each model portfolio:
The World Allocation Model is an all-ETF global asset allocation portfolio designed to reduce risk through diversification across the basic asset classes outlined previously. The percentages invested in each asset class can vary significantly from the passive portfolios, and unlike the strategic portfolios, asset classes can be excluded, hedged or shorted depending on conditions.
Our Global Opportunities Model is an all-equity portfolio that diversifies across the broad asset classes with the purpose of outperforming the S&P 500, while tolerating less risk. The portfolio is constructed using a top-down approach, concentrating first on economic outlook. A sector analysis is utilized, followed by individual stock analysis and then selection. The portfolio takes a long-term approach and turnover is minimized as much as possible to maximize tax efficiency.
The Trend Follower Model is a rules-based, momentum portfolio derived from the basic strategic models. The portfolio follows a strict set of technical trading rules developed by Alhambra Investments founder Joseph Calhoun and is intended to be defensive. It is primarily driven by the utilization of sound technical indicators, most notably the 50 and 200-day moving averages. Two variations of the model exist – US and International. Both variations of the model have not had a down year since their inceptions.
The World Bond Model is designed foremost as a capital preservation account. The primary investment is the Barclay’s (formerly Lehman) 1-3 Year Treasury Index which is a very stable, low-risk fixed income option. A range of fixed income options can be used when the risk/reward warrants. The portfolio consists primarily of fixed income ETFs and may include foreign currency bonds.
The Tax Free Model is designed as a capital preservation vehicle using tax-free municipal bonds primarily in the form of ETFs.
The Global Hedged Equity Strategy takes an equity portfolio and overlays hedging instruments, attempting to protect the underlying portfolio value during adverse market conditions and provide outsized returns in favorable conditions. The strategy seeks long term capital appreciation and to outperform the S&P 500.