David Finn UK Multi-Asset Portfolio Manager
Ben Banerji Portfolio Manager
Tactical Portfolio Allocations
02nd March, 2022
Portfolio Creation Process
There are four drivers of performance in your portfolio. In this series, we will look at each in detail, providing insights into how we build portfolios.
Tactical portfolio allocations is the final article in this series. To read the other articles, click here.
The portfolio creation process
Making tactical decisions to enhance portfolio returns
As we have covered in this series, your Strategic Asset Allocation (SAA) is the framework for your portfolio, providing the right level of diversification and with sufficient risk-taking to achieve your long-term objectives. Over short time periods, we expect that there will be market dislocations across asset classes, regions and sectors that will present both risks and opportunities to investors who can identify them.
These dislocations are not going to be captured within your long-term positioning but do form a part of what we call Tactical Asset Allocation (TAA).
In general, there are two levers that we can pull to alter your portfolio positioning on a tactical basis. The first is to go overweight or underweight at an asset class level; for example, increasing the risk (equity) allocation and decreasing the defensive (fixed income) allocation when we have a positive outlook for equities.
The second is to make changes within an asset class to move away from the benchmark. For example, within equities we could hold more of a specific sector or country (US financials or UK equities for example). Within fixed income, we could hold bonds with shorter maturity dates or lower credit ratings than the benchmark.
In financial markets, there is a great deal of news and deciding what is relevant and what is already being priced into the market is critical to the success of our tactical calls. To do this effectively, we follow a rigorous and repeatable process to identify our tactical investment opportunities.
The first step is to identify an asset class, country, or sector that we believe is showing signs of being under or over-priced.
The investment team then begin a deep dive into the data, to build an investment recommendation. The recommendation would typically contain the rationale for the tactical decision, the expected time horizon our strategists want to allow the call to be in place for, catalysts for the call under/outperforming the market and the potential downsides if we are wrong. The benefit of a team-based approach is that we can critically assess our decisions from different perspectives and with a variety of skill sets, which is crucial in building a strong thesis.
Once we are satisfied with the investment thesis, the next step is to find an appropriate instrument to express our view. Once the preferred instrument has been recommended by the Investment Selection team, further analysis is carried out to determine the appropriate sizing of the tactical call within portfolios. We look at several things here:
- how much risk exposure we want in our portfolios;
- the pay-off if our decision does well; and
- the potential loss if reality plays out differently from our expectations.
In general, we opt for a phased approach when implementing a tactical position. This gives us the flexibility to adjust our positioning, with the potential to increase our holding if the market moves against us while our view remains the same.
The final step of the process is the ongoing oversight of our open tactical calls to ensure they are performing within the range that we expected. As our intended time horizon is usually quite short (12-18 months), we have both time-based and performance-based triggers for an automatic review. Has our call done better or worse than expected, has our expectation been realised quicker or slower than we thought? This allows us to take swift corrective action if the market environment changes and our outlook is altered as a result.
Tactical Asset Allocation is an often misunderstood part of portfolio management, but for the reasons discussed, we believe it can be a real driver of relative outperformance in your portfolio.
Investment Strategy
Tactical asset allocation - bridging the gap between long-term market assumptions and current conditions.
Identify potential short-term mispricing
- Study third party and proprietary research and data to build an investment thesis.
Analyse and discuss rationale, catalysts and risks
- What may change our rationale?
- What do we know that the market doesn’t?
Determine appropriate instrument to express our view
- Active or passive?
- Identify best-in-class managers.
Right-sizing the portfolio position
- Balancing risk and return opportunity with appropriate portfolio sizing.
- Phased implementation.
Ongoing assessment and review
- Critical review and discussion of open calls.
- Monthly investment committee oversight.
If you would like to hear more about how our team of investment experts can help you build an investment strategy to meet your goals, please contact our office on +44 (0) 2890 310 655 and request a call with one of our Davy UK Wealth Managers.
To read more about the four sections of the portfolio creation quadrant, click on the articles below.
Strategic Asset Allocation
Your most important decision, how we help you arrive at an appropriate allocation and the implications for your long-term objectives.
Style Factor Bias
The group of characteristics that we look for in the stocks that underlie your portfolio.
Instrument Selection
The final part of portfolio construction, the individual instruments that convey our views.
Tactical Asset Allocation
How we invest your money with shorter term risks and opportunities in mind.
WARNING: The information in this article does not purport to be financial advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. You should seek advice in the context of your own personal circumstances prior to making any financial or investment decision from your own adviser.
WARNING: Past performance is not a reliable guide to future returns and future returns are not guaranteed. The value of investments and of any income derived from them may go down as well as up. You may not get back all of your original investment. Returns on investments may increase or decrease as a result of currency fluctuations.