Tactical Asset Allocation in Bull/Bear Markets
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Transcript of Tactical Asset Allocation in Bull/Bear Markets
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Tactical Asset Allocation in Bull/Bear Markets
Timothy J. Marchesi, CFAPresident, CEO & Co-CIO
DeMarche Associates, Inc.
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Agenda
• Importance of Asset Allocation
• Tactical vs. Conventional Approach
• Economic & Market Environment
• Supercycles
• Dynamic Investment Strategies
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Importance of Asset Allocation• Studies estimate that asset allocation decision
accounts for 91.5% of the variation between returns of different funds 1
• Asset mix optimization models mathematically seek maximum expected rate of return for a given level of risk (or minimization of risk for a given expected return) 2
1 Financial Analysts Journal, May/June 1991 – Brinson, Singer & Beebower2 Global Asset Allocation Techniques for Optimizing Portfolio Management, 1994 – Lummer & Riepe
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Review of Conventional Approach• Inputs based upon history• Typical models assume “average” future outcomes• Often ignore starting /ending market levels
Quarterly One-Year Returns1926-2009
Source: S&P 500 Index Some returns are greater than 50% and less than -50%
Large Capitalization StocksDistribution of Returns
0
5
10
15
20
25
30
35
40
Number of Occurrences
-50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50
Percent Return
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Review of Conventional Approach
• Typical models assume “average” future outcomes (sample chart below)
Today 2015 2020 2025 2030
12%
10%
8%
6%
4%
2%
Small Cap EquitiesLarge Cap Equities
Emerging Equities
Hedge FdsBonds
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One-Year Returns Are VolatileModels incorporate standard deviation to manage risk
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Model Optimization:The Efficient Frontier
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What is Tactical?
Webster’s: • “Small-scale action to serving a larger purpose”
In Investment Management:• Method of modifying asset allocation based upon
valuation estimates and judgments of the future return of markets or sectors
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Time Horizon for Investment Objectives
ShortTerm
Long Term
Investment HorizonInvestment Horizon
Market Timing
Tactical Asset
Allocation
Strategic Asset
Allocation
Secular Asset
Allocation
One Year Or Less
Current Market Phase Cycle
Several Market Phase Cycles
Multiple Market Supercycles
Asset Allocation Study has both a strategic perspective and a long-term secular perspective
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DeMarche Market Phases A typical market cycle has four distinct phases:
*Annualized cumulative returns of S&P 500 Index. Study based upon monthly data from 1/31/63-9/30/11. The annualized cumulative return for the full study period was +9.5%.
Source: DeMarche Research
Phase IV – Bear Market
Phase III – Late Bull/Early Bear
Phase II – Bull Market
Phase I – Early Bull
TotalReturn*
CorporateEarnings
StockPricesTactical Market Phase
Phase IV – Bear Market
Phase III – Late Bull/Early Bear
Phase II – Bull Market
62.0%
20.8%
0.5%
-27.0%
Phase I – Early Bull
TotalReturn*
CorporateEarnings
StockPricesTactical Market Phase
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Markets Change Markets change over long periods of time
• As markets change, relative value between asset classes changes
• DeMarche research has acknowledged and identified these long wave markets as “Supercycles”
• Multiple bull and bear markets exist within each “Supercycle”
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Supercycle YearsBank Panics/Recessions
Market Cycles(Bull/Bear Cycles)
A. High Growth 1900 – 1929 8 8
B. Moderate Growth 1929 – 1942 3 5
C. High Growth 1942 – 1966 5 8
D. Moderate Growth 1966 – 1980 3 6
E. High Growth 1980 – 2000 2 5
F. Moderate Growth 2000 - Present 2 3
DeMarche Supercycle Study
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Supercycle Beginning End DJIA Price Return*
A 1900 1929 +882%
B 1929 1942 -75
C 1942 1966 +701
D 1966 1980 +2
E 1980 2000 +1,444
F 2000 Present* -5
DeMarche Supercycle Study
*As of 3/31/2011. Cumulative returns are shown for each cycle (non-annualized).
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Supercycles Environment
A 1900 – 1929 High population growth
B 1929 – 1942 High unemployment
C 1942 – 1966 Baby boom / income growth
D 1966 – 1980 Inflation
E 1980 – 2000 Expansion of consumer credit
F 2000 – ? Demographics & debt
The Consumer in Supercycles
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New Normal Macroeconomic Environment
• Demographics “Boomers” retire or shift emphasis from consumption
to saving
• Consumers gradually improve their finances Paying down debt / increase savings
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New Normal Macroeconomic Environment (cont’d)
• Unemployment • Wage growth remains slow• Less help from asset gains (wealth effect)• Higher taxes
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Strategic Implications ofCurrent Supercycles
• Stock returns likely to underperform mean• Bond returns likely to underperform mean• Policies need other strategies to improve expected
risk/return outcomes
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Asset Allocation – Expected ReturnsNext 5 Year “Strategic” Period versus Long-Term “Secular” Time Horizon
Source: DeMarche Associates. See notes on next slide.
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Asset Allocation – Expected Returns (cont.)• Notes for chart on prior page:• Represents geometric return estimates for the 5 years
beginning January 2012, compared to long-term average geometric returns over multiple Supercycles (no specific beginning point). 5-year horizon utilizes an assumption of a moderate economic growth environment within the current Supercycle, as defined by DeMarche.
• U.S. Fixed Income has poor E.R. over the strategic period. Such assets presently have very low current income yield and are at risk of principal value losses as interest rates rise.
• Other asset classes are shown for comparison.
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Dynamic Investment Strategies
• Hedge Funds • Global Tactical Asset Allocation (GTAA) Funds• Lifecycle or Target Date Fund (TDFs)• Intro to some assets used by dynamic strategies
Commodities High Yield Bonds Emerging Market Bonds
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Brief Intro to Hedge Funds and GTAA Strategies
• Different HF Fund of Funds approaches for clients Conservative – emphasis on diversification, lower
volatility Strategic – more use of directional market bets,
leverage• GTAA is long-only, relative valuation-based• Fees higher with HF• Limited transparency with HF• GTAA correlation is high (vs. stocks/bonds)• Wide variance across manager/strategies
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Sample Range of GTAA Fund ApproachesClassic More Complex Comprehensive
Asset Classes Used
Cash X X X
Domestic Equity X X X
International Equity X X
Emerging Markets Equity X X
Domestic Bonds X X X
International Bonds X X
Emerging Markets Bonds X X
High Yield Bonds X
Inflation Protected (TIPS) X X
Convertibles X
Commodities X X
Real Estate (REITs) X
Listed Private Equity X
Currency X X
Typical Investments
Mutual Funds X X X
Closed-End Funds X X
Exchange-Traded (ETFs) X X X
Individual Securities X X X
Derivatives X X
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What is a Target-Date Fund?
• Description of TDF (or Lifecycle Fund): Diversified investment option Target a specific retirement year (2020, 2030, etc.) Professionally managed
– Stock allocation reduced as retirement year nears– Disciplined rebalancing of underlying funds
May use less-traditional investments
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Example of TDF Asset Allocation
Source: PIMCO, compiled by MarketGlide.
Fewer equities as participant retire date nears
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TDF Glidepaths Programs reduce equities over time; some have tactical range
Active Average vs Passive Average
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20
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60
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100
2055 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 2000 1995
Perc
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tag
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qu
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All
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PassiveManagerAverage
ActiveManagerAverage
IndustryMax
IndustryMin
Glidepath
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Total return from commodities comes from combination of: rolling futures contracts (roll yield), yield from the cash collateral, and the spot price gain or loss. Derivatives use is widespread (active or passive).
Brief Intro: Commodities• Energy, Metals, Agriculture, Livestock• Weights differ among several indexes
S&P has 65-75% Energy: others cap at 33%• Portfolio diversifier
Hedge against unexpected inflation Slight negative correlation to stocks & bonds in past
• Liquidity varies; fund choices very distinct• Key concerns: China, oil, gold
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Brief Intro: High Yield & Emerging Market Bonds• Both have low correlations to U.S. Bonds• U.S. High Yield Bonds
Quality ratings of “BB” or lower (below investment grade) Average maturities 3-10 years High level of current income payments Default risk rises in recessionary periods Higher volatility and potential losses than other fixed income
• Emerging Market Bonds are investment grade Obligations of foreign government or corporation Average maturities 3-10 years Higher fees (management, transaction, custodial) Political, liquidity, and other risks differ from U.S. bonds Currency risk (some issued in U.S. dollars)
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Recommendations
• Adjust asset allocation more frequently• Incorporate Supercycles• Emphasize liquidity• Diversify• Increase allocation to dynamic strategies
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Questions?
Thank you!