What is 'Tactical Asset Allocation - TAA'

Tactical asset allocation is an active management portfolio strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors.

This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace. It is as a moderately active strategy since managers return to the portfolio's original strategic asset mix when desired short-term profits are achieved.

BREAKING DOWN 'Tactical Asset Allocation - TAA'

To understand tactical asset allocation, one must first understand strategic asset allocation. During the process of creating an investor policy statement (IPS), factors such as required rate of return, acceptable risk levels, legal and liquidity requirements, taxes, time horizon and unique circumstances are analyzed to settle on a strategic mix of assets to include in an investor's portfolio. The percentage that each asset class is weighted over the long term is known as the strategic asset allocation. This is the mix of assets and weights that will help an investor reach their specific goals.

This is a simple example:

Cash = 10%

Bonds = 35%

Stocks = 45%

Commodities = 10%

The Usefulness of Tactical Asset Allocation

Tactical asset allocation is the process of taking an active stance on the strategic asset allocation itself and adjusting these long-term target weights for a short period of time to capitalize on market or economic opportunities. For example, assume that data suggests that there will be a very large increase in demand for commodities over the next 18 months. It may be prudent for an investor to shift more capital into that asset class to take advantage of the opportunity. While the above portfolio's strategic allocation will remain the same, the tactical allocation may then become:

Cash = 5%

Bonds = 35%

Stocks = 45%

Commodities = 15%

Tactical shifts can also occur within an asset class. Assume the 45% strategically allocated to stocks consists of 30% large cap and 15% small cap. If the outlook for small-cap stocks does not look favorable, it may be a wise tactical decision to shift the allocation within stocks to 40% large cap and 5% small cap for a short time until conditions change.

Usually, tactical shifts range from 5 to 10%, though they can be lower. In practice, it is very rare to tactically adjust any asset class by more than 10%. This would show a fundamental problem with the construction of the strategic asset allocation.

Tactical asset allocation is different from rebalancing a portfolio. During rebalancing, trades are made to bring a portfolio back to its desired strategic asset allocation. Tactical asset allocation simply adjusts the strategic asset allocation for a short time with the intention of reverting back to the strategic allocation once the short-term opportunities disappear.

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