Swedroe: Beware Tactical Asset Allocation

Tactical asset allocation is really nothing more than badly timed market timing.

Reviewed by: Larry Swedroe
Edited by: Larry Swedroe

Tactical asset allocation is really nothing more than badly timed market timing.


The financial crisis of 2008 has led to another surge in demand for funds using a tactical asset allocation (TAA) investment strategy. Morningstar currently classifies about 332 funds as tactical asset allocation funds. That’s up from just eight in 2007.

The objective of TAA, which originally gained popularity in the 1980s, is to provide better-than-benchmark returns with (possibly) lower volatility. This is accomplished—theoretically—by forecasting the returns of two or more asset classes, and then varying portfolio exposure (or percent allocation) accordingly. The varying exposure to different asset classes on which the tactical asset allocation strategy is based depends on economic and/or market (technical) indicators.

The performance of a TAA fund is measured against its benchmark. While the benchmark might typically be a 60 percent equity allocation to the S&P 500 Index and a 40 percent fixed-income allocation to the Barclay’s Aggregate Bond Index, the fund manager might be allowed the discretion to have allocations range anywhere from 50 percent to 5 percent equities, 20 percent to 50 percent bonds, and zero percent to 45 percent cash.

Market Timing By Another Name

In reality, TAA is just a fancy name for market timing. It’s simply another way to charge higher fees.

So how has the Morningstar Tactical Asset Allocation category performed relative to a portfolio allocated 60/40 to the S&P 500 Index and the Barclays Aggregate Bond Index?

Morningstar reports that, over the three years ending July 2014, these funds have gained an annual average return of 7.8 percent, or 3.8 percentage points per year behind their benchmarks. And these findings are nothing new.



How Bad Is Bad?

Previously, Morningstar examined the returns of 163 TAA funds for the period ending July 2010. It’s important to note that 39 of the funds disappeared during the study period because of merger or liquidation. Of the surviving tactical strategy funds, the median life span as of July 31, 2010 was 37 months.

That study found that TAA funds generally failed to deliver better risk-adjusted returns, or downside protection, than a traditional balanced index portfolio split 60/40 between stocks and bonds, respectively.

For example, 64 of the 92 TAA funds at least a year old—that’s 70 percent—had worse performance since inception than the passively managed Vanguard Balanced Index Fund (VBINX). The average underperformance was 2.6 percentage points per year.

Morningstar later updated the study through the end of 2011. It again compared the returns of TAA funds to Vanguard’s Balanced Index Fund (VBINX), which passively invests its assets in a 60/40 stock/bond mix. The following is a summary of its conclusions:

  • Very few TAA funds generated better risk-adjusted returns than VBINX.
  • Just nine of the 112 TAA funds in existence over the period from August 2010 through December 2011 had higher Sharpe ratios (a measure of risk-adjusted returns) than did VBINX.
  • Only 27 of the funds experienced a smaller maximum drawdown than VBINX. The majority of the funds experienced larger peak-to-trough declines.
  • Only 14 of the 81 tactical funds in existence since October 2007 posted lower maximum drawdowns than VBINX during the 2008 financial crisis, the correction during the spring and summer of 2010, and during the recent European debt-related drawdown. Put another way, just 17 percent of the TAA funds consistently provided the insurance investors were paying for.

Keep these results in mind the next time you are tempted by the tactical asset allocation strategy. Bottom line: big fees, poor results. In other words, TAA is just another game where the winners are the product purveyors, not the investors.

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


Larry Swedroe is a principal and the director of research for Buckingham Strategic Wealth, an independent member of the BAM Alliance. Previously, he was vice chairman of Prudential Home Mortgage.