The 2008 financial crisis caused investors to gain a true appreciation of market volatility. We saw that market declines can be fast, furious and nasty. During this period, there were thousands, if not tens of thousands, of articles and editorials proclaiming the benefits of tactical investment management. Tactical management has been around for years, but its popularity increased with the financial crisis.
What is tactical investment management? It is an approach where the portfolio manager dynamically shifts the asset allocation (investment mix) in response to market trends and macro-economic conditions. Tactical supporters assert that this approach is most effective when markets are flat or down.
If you’ve been to one of our investment workshops, you know I would say tactical management is simply “market timing” in disguise.
Let’s examine the latest research into tactical management.
In 2010and 2012, Morningstar looked into tactical mutual funds performance. They compared these funds against Vanguard's Balanced Index Fund (VBINX), a 60% stocks/40% bonds mix. In both studies, Morningstar discovered that tactical funds failed to deliver better returns or downside protection.
Of the 112 tactical mutual funds that existed throughout the entire analysis period in the 2012 study, Morningstar found:
1. Only 9 funds (8.0%) had higher risk-adjusted returns than the Vanguard fund.
2. 27 funds (24.1%) offered better downside protection.
3. 85 funds (75.9%) experienced greater declines than the Vanguard fund.
Point 3 shoots down the assertion that tactical management is most effective during market declines. The results are underwhelming.
Tactical management suffers from the same folly of all active management. Specifically, it is based on some prediction about the future. The tactical manager can make a big bet and get it wrong. That’s a big risk! Morningstar showed they get it wrong three-fourths of the time.
These studies—along with others—prove that chasing hot returns, hot managers and recent trends is a losing game.
There is no empirical evidence that shows active management works over the long term.
Risk-adjusted returns indicate whether a mutual fund’s returns are the result of “smart” investment decisions or excess risk