Beware Tactical Asset Allocation

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.

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