When markets are volatile, investors need a plan
Investors are typically told to invest for the long term. But that doesn’t mean they shouldn’t adjust their portfolios in turbulent times like those we’ve witnessed during the pandemic.
Adjusting a portfolio though, isn’t like day trading. It’s actually done by taking small steps. This allows you to take advantage of those parts of the market that may be undervalued or offer better opportunities. For example, technology stocks did well in the first year of the pandemic. However, later in anticipation of the economy reopening, value stocks at times outperformed growth stocks like technology. Investors who adjusted their portfolios were able to take advantage of this trend.
So in some ways tactical asset allocation is like being a pilot. If there’s a thunderstorm ahead, you may need to make some different decisions to make sure you can make it to where you need to go.
Tactical asset allocation does this by allowing the manager or investor to adjust a portfolio’s mix to try to improve shorter-term returns. It’s usually done by making small shifts over several months, with the hope of adding incremental return. To do this, the portfolio managers look beyond the headlines to understand market risks and opportunities.
Central banks to cut interest rates to effectively zero in the COVID-19 pandemic. And leadership in the markets shifted at one point to favour value stocks over growth stocks. These were two trends that caused many portfolio managers to make tactical moves. For example, they could have shifted into U.S. value stocks in anticipation of the post-pandemic economy emerging. And because bond prices generally fall as interest rates move higher, they may have underweighted some classes of bonds on the assumption that rates could rise.
Seeing the big picture
Tactical asset allocation decisions are often made by looking at broad economic factors. These include such things as, global growth rates, valuations across different markets, monetary and fiscal policy, as well as market sentiment.
The goal is to add value by overweighting certain asset classes that are expected to outperform in the near term and underweighting others that are expected to underperform. This is done at a macro level, rather than trying to predict how individual companies are going to perform.
Three ways tactical asset allocation can help
Enhancing returns
Managers make tactical decisions to potentially capture opportunities, rather than just to avoid risk. To seek additional returns, they often strive to capture the potential upside from the broader fundamentals. This often means putting your money where you get the best reward for the risks you’re taking.
Mitigating risk
Tactical moves can also be made to potentially protect a portfolio’s value. This means the portfolio manager aims to capture the upside when the broader fundamentals look very strong, but will also want to protect the downside.
Tactical decisions may also be used when market cycles start to shift. If, for example, as we’ve seen in a low interest rate environment, investors might allocate more of their assets to growth stocks. However, when interest rates threaten to rise as economic growth accelerates it could be time to move back to value stocks and cyclicals.
Managing volatility
Market volatility will always come and go for number of reasons. For example, the threat of rising interest rates and inflation can trigger volatility.
But fortunately, volatility is not necessarily a negative.
This is because it creates an opportunity for asset management, including using tactical asset allocation to potentially enhance risk-adjusted returns.
Ultimately, being tactical may provide a smoother ride as markets rise and fall. That, in turn, could give investors potentially more confidence to weather market storms.
