Theoretically, we all know that when it comes to investments, we need to set reasonable expectations. Practically, however, it’s a different story.
Who among us hasn’t woken up and checked their portfolio to see if they became a millionaire overnight and could quit their jobs? The mind understands that we need to make our peace with sustainable returns. But the heart wants what the heart wants.
Well, what if you could listen to both? What if you could switch your portfolio allocation to take advantage of the changing market conditions without compromising on its integrity?
Tactical Asset Allocation can help you with just that. How? Let’s find out!
Understanding Tactical Asset Allocation
As the name suggests, this is an investment strategy that adjusts a portfolio’s asset mix in response to changing market conditions.
It’s a more fluid approach, as you can imagine. Nothing is set in stone over here, and we keep adjusting the portfolio allocation depending on how the market reacts.
Imagine, for instance, that you’ve created a well-balanced portfolio for yourself, with a primary concentration of large-cap stocks.
Now your portfolio is stable and it’s doing well. But you want more. What you can do, is set aside a certain amount that you can invest more tactically.
What does this mean?
Well, let’s say the fintech sector is starting a bullish run. You have a couple of large banking stocks in your portfolio already. But you want to invest in a few other promising companies coming up in the investment space.
Setting aside a fraction for tactical allocation allows you to do just that. You don’t have to sell off any of your long-term investments.
Oh no, your strategic asset allocation remains undisturbed. Instead, you make some extra investments in some mid-caps in the BFSI space, with the objective of earning higher returns. This can, of course, be for the short-term or the long-term, depending on how the investment plays out.
But that’s the beauty of tactical allocation. You have the flexibility to alter your investments whenever you want.
Principles of Tactical Allocation
- Flexibility
This is the premise on which tactical asset allocation is based. You need flexibility in order to adjust your portfolio.
It doesn’t mean you need to switch up your entire portfolio. But at least a portion of it needs to be dynamic.
- Market Analysis
This is a prerequisite. You need proper and rigorous market analysis in order to capitalise on macroeconomic trends, interest rates, corporate earnings, geopolitical events and the like.
- Risk Management
Now, tactical asset allocation is not just about increasing your returns. Often, it is also used as a hedging and risk management technique.
Imagine, for instance, that the market is going through a downturn. In such a situation, you’ll want to add some contra or defensive stocks to your portfolio to weather the storm.
Tactical Asset Allocation in Mutual Funds
As you can imagine, tactical asset allocation is a strategy used by actively managed mutual funds. The objective here is to beat the market and generate higher returns for the portfolio.
Funds like dynamic asset allocation funds, or even multi-asset allocation funds use the concept of tactical asset allocation to maximise returns to their portfolios.
The fund managers, in this case, use a variety of indicators to gauge what the overall outlook of the market is, and which way it’s going to go.
For example, macroeconomic indicators like GDP growth and interest rates can have quite an impact on investment decisions.
Say, for instance, GDP growth is in line with the expectations, and inflation is within RBI’s acceptable limits. The market outlook is positive overall, and the fund manager decides to increase the equity allocation to take advantage of the anticipated growth in the stock market.
How?
They increase exposure to sectors like consumer goods, technology and others that are expected to benefit from the economic growth.
Similarly, if the market starts to anticipate that RBI will introduce a rate hike, the situation will change again. From optimistic, the mood will now change to cautious.
In this situation, the fund manager will decrease exposure to interest rate-sensitive sectors and increase allocation to sectors that benefit from higher rates like financials.
The fund manager may also go one step beyond and increase the allocation to short-term bonds to reduce interest rate risk.
What are the Challenges?
Tactical asset allocation can offer numerous benefits for your portfolio. After all, the entire objective of this strategy is to maximise your returns. Can there be anything more ideal?
Having said that, however, you must remember that this strategy does not come without risks.
- Market Timing
Timing the market is the key here.
The fund manager needs to anticipate and take the right call before the tide actually turns. But that is hard to do as it sounds.
It is very easy to go wrong when you’re playing with the edge of a knife, and any missteps can be disastrous. Incorrect timing decisions can lead to suboptimal performance and increased volatility.
For example, if the fund manager increases equity exposure just before a market correction, it can result in significant losses to the portfolio!
- Higher Costs
Tactical asset allocation involves active management. You need to keep buying and selling shares and rebalance the portfolio frequently.
This can lead to higher transaction costs and taxes, which in turn, can erode returns.
- Complex
Although this explanation of tactical asset allocation can sound simple, let me assure you that implementing this strategy is anything but. Fund managers use sophisticated models and tools for effective implementation.
- Behavioural Biases
No matter how hard we try, there is some bias in our decisions. Fund managers, of course, are experts. But even then, behavioural biases creep in.
Now, in normal situations, this might not even matter.
But, when you’re attempting to beat the market, this can often lead to overconfidence or even herd behaviour. This, in turn, can have an impact on decision-making and performance.
Summing Up
Tactical asset allocation is powerful. But don’t go all out with it.
“Tactical portfolio generally shouldn’t be more than 20-25% of the overall portfolio based on product availability, lock-in and client comfort, and are generally meant for short periods.” — Nitin Rao, CEO, InCred Wealth, in a 2023 interview with Mint.
As with all other investment strategies, only go as far as you’re comfortable. With mutual funds, of course, you can explore tactical asset allocation in a safer manner.
Remember, TAA isn’t about becoming a millionaire overnight. It’s about being nimble, adapting to market conditions, and potentially enhancing your returns. But like a powerful sports car, it needs skilled handling. For most of us, a TAA mutual fund might be the equivalent of taking that sports car for a spin with a professional driver at the wheel.
Simply choose the fund you’re comfortable with and invest!
Oh, and don’t forget to track the performance of your portfolio with Dezerv’s wealth monitor!
After all, in the world of TAA, knowledge isn’t just power – it’s profit!