Our evolved modeling process thinks about a well-diversified client portfolio consisting of three distinct mandates:
Mandate 1 - Strategic Market Movement
Targeted to a point on the efficient frontier and rebalanced back to that target. This is a buy and hold sleeve, looking for full market participation. Vanguard, Loring Ward, Wilshire and others utilize their own research to optimize their portfolios in this sleeve for us.
Mandate 3 - Diversifiers
Counterbalance to the first sleeve where, in partnership with Rocaton Advisors, we search for strategies that produce alpha by actively trading numerous asset classes and investment themes. AQR, Blackstone, Blackrock, 361 Capital and Ocean Park Asset Management are just a few of the talented teams within this mandate.
Mandate 2 - Tactical Market Movement
Between these sleeves of full market participation and almost no market participation, we have Mandate 2 Tactical Market Movement where we offer the opportunity for a management team to utilize non-persistent beta, to make ongoing decisions as to entry and exit points within markets and to add value and create more return for the amount of risk they are taking. This is the free lunch, the Silver Bullet. This is where the client who wants all the return but won’t tolerate the risk wants to live.
Since the beginning of the Asset Allocation movement 25 years ago this management style has been the focus of great debate. It is only in the last decade that tactical allocation has taken its place next to strategic as a legitimate, and consequently much sought after, option for both institutional and retail investors. For decades it was the red headed stepchild to the supposedly more academically sound and scientifically provable efficient market theory of strategic allocation. While the bear markets have changed the culture, a reality does exist. Tactical management is hard and the recent past is littered with strategies that looked like they had found the secret formula, only to remind us all that tactical is no substitute for strategic, it is a complimentary sleeve and should not be offered as a stand-alone alternative. Recent “Silver Bullet” strategies:
These are examples of firms which, working from a relatively small asset base, had versions of tactical timing models that missed a downdraft in either 2000-2002 or 2008, then marketed that downside protection as the prudent way to manage money, grew their assets dramatically, and then failed to sustain their momentum as they either underperformed on the upside or got whipsawed by changing volatility patterns while their benchmarks increased nicely.
The most recent example of Good Harbor’s flagship product losing over 21% in 2014 while the S&P gained 13% shows the compounding effect improper expectations may have on a client portfolio. If this strategy was coupled with a pure beta allocation, and the tactical was a component, then although damaging, at least the client participated in the strategic sleeve. But sadly, historically these types of strategies have been oversold as a substitute for full market participation.
The firms listed above had nothing but the best intentions for their advisor and client base. They did not misrepresent their products capabilities like the folks marketing F-Squared, but we do believe that the pattern represents a cautionary tale for all of us. Several of these firms, notably Niemen, have bounced back and are offering great returns, but their particular audience has moved on in search of the next “sure thing”. We think that rather than positioning tactical timing, or tactical in general, as a Silver Bullet for the portfolio, we need to clarify that it is one segment; one Mandate, of a Multi Mandate evolved allocation.
This should be the portion of a portfolio that has opportunities in choppy, sideways markets. The managers here should show a history of not replicating the same exact risk pattern as the strategic portion of their portfolio. If moving to cash is of interest to a client, then this is the portion of the portfolio that might have that potential. Above all, as trusted advisors we should have a reasonable understanding of the longer term risks of this type of strategy, what are the potentials for whiplash, what are the triggers for getting back in once out, is there leverage being applied that exacerbate the inevitable wrong turn, and maybe most importantly is the team responsible being intellectually honest with us, and themselves, as to their ability and contribution to the whole?
We are huge fans of tactical management. Fortunately our due diligence has steered us clear of any of the above disappointments; this has been more about realistic expectations than anything else. With the release of our new Market Movement Strategies, our commitment will continue to be the same. Work with capable firms and watch them closely. Our new partnership with Rocaton Advisors adds significantly to that promise. Above all, strive for clarity and consistency and don’t only search for the Silver Bullet as we may miss too many good opportunities along the way.
The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. FTJ FundChoice does not guarantee any minimum level of investment performance or success of any index portfolio or investment strategy. Past performance is not indicative of future results. Indices are unmanaged and their returns assume reinvestment of dividends and do not reflect any fees or expenses. It is not possible to invest directly in an index. Information obtained from third party sources are believed to be reliable but not guaranteed. FTJ FundChoice makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.