A Graveyard for Tacticians
- Joshua M Brown
- November 30th, 2012
Whatever the market historians say about the 2012 stock market years from now, they will certainly have to at least mention how difficult it was for those who practice tactical asset allocation. Not just difficult, actually it was a graveyard.
I'm going to show you why:
In 2012, there were very few ways to win and lots of ways to lose if you were doing any kind of market timing at all.
First of all, you had to have come into the year fully-invested, both barrels loaded. You also had to have been at least equal-weighted to Apple. Thus, if you had a value-bent (versus a growth-bent) to your allocation, you got smoked. The year's gains are front-end loaded, which means if you lagged that January to April run, you almost never had a chance to catch up.
Second, there were two major fakeouts for those employing a 200-day or ten-month moving average as a buy/sell signal. The Spring sell-off, driven by Europe, culminated in one of the nastiest bull reversals I've ever seen. You got taken out of stocks only to watch a V-shaped snapback humiliate you within hours - not days but hours! It was insane.
By September, the performance chase had pushed the market to a new year high, only to suck everyone back in right before the fiscal cliff / global recession zeitgeist started to make itself felt again. A horrible earnings season in which "uncertainly" punctuated every conversation had ended with a second fakeout for the tacticians to impale themselves on. Just when it looked as though we were finally going to get a real correction and stocks had broken below the 200-day, the unthinkable happened: The light-volume and shortened holiday week saw one of the most incendiary stock market runs of all time. In three-and-a-half days the S&P had gained back almost the entire correction in a run that seemingly included no one. Apple alone had ripped from 505 to 590 within what seemed like seconds! Forgetaboutit!
Once again, trend-followers and timers got smoked before they even knew what had happened. In the time it takes you to open the Yahoo Finance app on your iPad, the reversal had beclowned all but the buy-and-holders.
Many years from now, people will see the 2012 stock market's 15% return in a box on one of those periodic tables of asset class returns and they'll say, "Hey, 15%, that was a good year." They will have no idea how terribly tough a year it was for anyone who wasn't aggressively long Apple from January through the spring.
And here's the worst part, this couldn't have happened at a worst time for tactical managers - just when their premise was finally coming into its own among Wall Street traditionalists, it's been cut down. As a well-known drunk driver and sometime singer-songwriter once said, only the good die young.
Now let me take one step back for a moment - the events of 2007-2009 proved to the investing public that buy-and-hold wasn't a legitimate strategy for their retirement assets anymore. This meant much recrimination of the fully-invested-always strategies that have dominated the asset management and retirement investing complex for decades. The money was pulled away from those who sat fully-loaded for the peak-to-trough 57% drop in the S&P.
But in the investment management biz, when a door is slammed shut, a window is opened.
Enter the Tactical Asset Manager with an idea that appeared to have been perfectly suited for a generation of jittery, post-traumatic stress disordered investors. Some of these tactical managers had track records that had shone like diamonds versus the 3- and 5- year numbers for the benchmark S&P. Most of them, however, did not even exist prior to the crash. It didn't matter, investors grabbed them up like Winona Ryder in a dimly-lit department store.
Jason Zweig at the Wall Street Journal looked at the the 42 mutual funds that label themselves as tactical asset allocators earlier this month (see: How Practical is Tactical?). He had trouble finding anything positive to say about them as a group. First, he found that of the 42, only 8 of them had been around prior to 2007. In addition, this category of funds had raised 20% of its $4.3 billion in AUM in 2012 alone. And as with any investing craze, the results have not been great:
As usual, investors appear to have stampeded into a trend at an inopportune time. Mutual funds with "tactical" in their name are up 6.9% this year—an average of five percentage points less than the various indexes they follow, according to Morningstar. Over the past three years, these funds have gained an annual average of 4.9%, or more than six points a year behind their benchmarks.
Now of course, the tactical managers will retort with the following:
1. We're not designed to outperform in every environment
2. We're seeking a return with lower-volatility than the overall market, which means giving up some upside sometimes.
3. Had the markets been substantially lower rather than higher in the last 12 months, this article would never have been written.
4. Tactical is only meant to represent a sleeve of a total portfolio, not the entire strategy.
5. One or two years do not accurately reflect the true advantage of Tactical over time.
6. We'll get 'em next year.
Now of course, these are all legitimate points to varying degree. Many investors will remain somewhat tactical and allow these funds and vehicles more time for this promise to bear itself out. But many won't.
In addition, now that the 3-year numbers begin to look unfavorable versus the benchmark S&P, you'll also see much less capital allocated toward them. These are the facts. Don't be surprised if 2012 ends up being the year that killed a few of these things dead given the massive underperformance.
My guess is that balanced funds become the beneficiary of this. The return + volatility of a combination stock/bond fund will look like a vastly superior option to the tactical allocator and in many cases its expenses and turnover will put it over the top. Another door slammed shut, another window opened.
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.