PARTNER INSIGHT: Seen as the building blocks of a portfolio, strategic and tactical asset allocation processes should work in tandem to deliver on-target and risk-adjusted returns. Here, the two processes are analysed to see how they complement each other to deliver long-term results.
Investment returns from even the most well-diversified multi-asset portfolios are likely to be subdued for the foreseeable future as an environment of super-normal monetary policy and low yields continues.
For many investors the key to delivering better multi-asset returns comes down to using complementary strategic and tactical asset allocation processes.
While the difference between strategic and tactical allocation is fairly clear cut, more often than not the same fund team is involved in researching and implementing both. Yet the two forms of allocation require significantly different approaches and ways of thinking.
"Investment markets constantly adjust to new information and asset prices can often be more volatile than the underlying fundamental. This can lead to them overshooting based on changing investor perceptions on a short-term basis," explains Barry Widdows, Head of Multi-Asset Portfolio Management at Prudential Portfolio Management Group (PPMG). "This volatility can create mispricing of asset classes and it is only through a tactical asset allocation process that managers can take advantage of those trends and opportunities. We believe that the best way to generate strong absolute returns and alpha is to start with a really strong strategic asset allocation as a foundation and combine that with a modern dynamic tactical asset allocation process.
Widdows believes an individual focus on both of these areas is key to delivering returns in multi-asset today, as both processes provide quite different market insights that are able to inform portfolio decisions in unique ways. The group's long-term investment strategy team for example analyse a range of strategic factors and aim to position a portfolio to benefit from the medium to long-term capital market views. This process allows the team to take into account the secular views and associated regime changes likely to happen, as well as broad high level perspectives on the current cycle into the investment philosophy.
Meanwhile, a separate portfolio management team focuses on tactical asset allocation which is a secondary research process that complements strategic asset allocation as a whole. On a tactical basis, the portfolio management team aims to analyse shorter-term behavioural and market timing insights on anything from a one month to 18 month outlook.
Phil Butler, Multi-Asset Portfolio Manager at PPMG, explains: "The way we frame our theory is strategic asset allocation is looking at an outlook of three-to-five years plus. And whilst a rational investor should price an asset to return its objective over long time frames of this sort, in the short term assets do tend to deviate away from their true value. Our aim is to tactically take advantage of those opportunities that are presented before us."
The evolution of tactical asset allocation in the industry over the past 15 to 20 years has seen a growth in the asset class coverage, according to PPMG. At the time of the tech bubble in 2000 for example, tactical asset allocation was focused on stock/government bond decision. But the early 2000's brought a widening of opportunity sets, with regional equity and bond markets being added to the stocks/bonds/cash decision.
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