[Tactical asset allocation as an investment strategy has engendered both strong proponents and tough detractors over the years. We can see varying results when reviewing different time frames for performance, but then many investment styles have similar in-favor and out-of-favor periods. So, as proponents and detractors argue with each other, it needs to be noted that it might not be a matter of whether tactical asset allocation works or not, but what type of environment you are in. With all the confusion and volatility in the markets today, it may be a good time to take a harder look at tactical investing.
As an example of a detractor’s position, last year Morningstar wrote a highly negative piece on Tactical Asset Allocation stating, “this investment strategy is notoriously difficult to implement in practice” and did not recommend the investment approach, to say the least. The article though did go on to qualify their opinion by acknowledging a few tactical managers that have been able to implement tactical approaches with a degree of success.
To get a different perspective, we reached out to the asset manager Morningstar positively cited as generating “some of the category’s best long-term returns by using a flexible approach to asset allocation,” the Leuthold Group — a Minneapolis-based market research and money management firm that recently became an Institute corporate member. We asked Leuthold Group’s co-CEO John Mueller questions to better understand tactical asset allocation, address misconceptions and discuss the investment strategy’s unique place in today’s portfolios.]
Bill Hortz: Having been founded as an independent investment research firm providing original analysis for the institutional marketplace, why did you decide to form an investment management arm centered on tactical asset allocation and quantitative methodologies?
John Mueller: The decision to apply the internal research and analysis into an investable portfolio was made prior to my joining the firm, but I know the story. Steve Leuthold was well known in institutional research circles and frequently published his views on the market, allocation recommendations, and so on. The portfolio managers, who subscribed to the research and had their performance measured daily, suggested that Steve should “put his money where his mouth was.”
They implied being a successful strategist and writing about calls was one thing, while implementing decisions in an investable portfolio was quite another. So, in 1987, the Core Investment Portfolio was born. Net equity exposure in the portfolio was dramatically underweight leading into the October crash, so Steve gained some credibility right out of the gates.
Hortz: How do you define what tactical asset allocation is and how do you go about implementing the strategy? What disciplines need to be in place to execute a tactical strategy that is not going to shoot you in the foot at the wrong time?
Mueller: We believe tactical asset allocation is primarily about flexibility. To properly execute a tactical strategy in different market environments requires the latitude of a broad opportunity set. Additionally, there is a certain level of nimbleness required to implement a flexible strategy. To effectively manage a tactical asset allocation strategy, being smaller and not capacity constrained is a huge advantage.
Lastly, it is our firm belief that you need to have processes in place intended to remove emotion and instill discipline. Our time-tested models have helped us to make tactical moves at times when it is difficult to do so, often going against the crowd.
Hortz: What are some of the different internal components or tools you use in your strategy that have been most effective?
Mueller: We have a number of sub-strategies and models we employ within our flagship Core strategy that have contributed to our long-term success. Beginning with our Major Trend Index (MTI) which we publish for our research clients on a weekly basis. This model is designed to gauge the overall health of the equity markets and helps us to position our portfolio to best reflect the current environment. The inception of the MTI dates back to the 1970s and while it has evolved over time, it still maintains its primary components.
Once we determine our desired net equity exposure, we manage it with a balance of our long equity strategy (Select Industries) and our short equity strategy (AdvantHedge). We have been managing both strategies successfully for decades.
Select Industries, as the name implies, leverages our monthly industry group research, focusing on owning the attractive groups and avoiding the rest. Flexibility is key to Select Industries’ long-term outperformance as well.
AdvantHedge leverages a bi-weekly screen we run to identify the weakest stocks within a broad, liquid universe. The approach takes small positions and utilizes a rules-based approach, critical in managing a short position. This hedge allows us to hold the equities we believe in, while reducing market exposure without realizing excess capital gains.