What Does Recent Strategic Asset Allocation's Outperformance Over Tactical Tell You?

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 |  Includes: BOND, DBC, DVY, EFA, FVD, GTAA, HYG, IAU, IEF, LQD, QQQ, SPY, TIP, VEA, VNQ, VNQI, VTI, VWO, VYM
by: MyPlanIQ

Since the great recession, government driven monetary policies have consistently propped up risk assets such as stocks to elevated levels. This helps strategic asset allocation (buy and hold and re-balance) portfolios outperform tactical allocation (dynamically adjusting risk asset exposure) portfolios. This is illustrated by the following performance comparison:

Portfolio/Fund Name 1 Week
Return*
YTD
Return**
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation - Equal Weight Moderate 0.0% 7.7% 13.8% 118.7% 8.9% 76.2% 2.6% 14.9% 8.1% 57.5%
MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation - Optimal Moderate 0.3% 9.5% 17.3% 140.4% 10.2% 84.6% 5.0% 28.5% 9.7% 65.7%
MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate 0.3% 6.3% 7.9% 132.3% 7.8% 69.2% 7.6% 64.5% 11.2% 93.7%
Click to enlarge

*: NOT annualized

**YTD: Year to Date

Symbol 1 Yr 3 Yr 5 Yr 10 Yr Inception 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001
AR(%) P_19495 13.8 8.9 2.6 8.1 6.0 7.7 0.6 12.1 22.0 -24.1 10.8 16.9 9.4 8.6 23.5 -7.4 0.6
P_39680 17.3 10.2 5.0 9.7 4.6 9.5 1.0 15.6 23.0 -19.6 12.6 15.4 8.5 8.9 23.9 -14.4 -18.1
P_19489 7.9 7.8 7.6 11.2 9.8 6.3 1.2 8.7 17.3 0.5 23.3 17.8 10.6 8.5 17.8 3.1 2.3
SharpeRatio(%) P_19495 118.7 76.2 14.9 57.5 39.8 102.1 4.8 113.2 131.9 -113.6 78.3 156.4 118.8 89.9 227.5 -62.6 -24.0
P_39680 140.4 84.6 28.5 65.7 21.4 111.5 7.4 129.4 127.1 -91.5 91.8 150.0 99.2 105.3 220.0 -92.5 -67.2
P_19489 132.3 69.2 64.5 93.7 85.6 104.9 13.2 60.0 132.4 -4.9 134.0 117.9 102.2 96.5 228.2 37.2 0.5
DrawDown(%) P_19495 6.7 10.5 36.3 36.3 36.3 5.4 10.5 6.8 14.6 36.1 6.0 10.0 3.8 7.5 7.5 16.3 9.7
P_39680 7.2 11.9 33.6 33.6 45.0 6.3 11.9 7.8 16.0 32.1 5.9 6.9 3.8 6.0 7.6 24.1 38.7
P_19489 4.8 10.5 11.2 14.1 14.1 4.8 7.5 10.5 5.7 11.2 10.0 14.1 5.1 7.6 4.3 5.8 0.0
Click to enlarge

The above compares the two strategic asset allocation portfolios with a tactical asset allocation portfolio. These portfolio's candidate funds include the following:

LARGE BLEND VTI Vanguard Total Stock Market ETF
LARGE GROWTH VUG Vanguard Growth ETF
LARGE GROWTH QQQ PowerShares QQQ
LARGE VALUE DVY iShares Dow Jones Select Dividend Index
LARGE BLEND VTI Vanguard Total Stock Market ETF
LARGE VALUE VTV Vanguard Value ETF
LARGE GROWTH VUG Vanguard Growth ETF
MID-CAP BLEND VO Vanguard Mid Cap ETF
LARGE GROWTH QQQ PowerShares QQQ
LARGE VALUE DVY iShares Dow Jones Select Dividend Index
Mid-Cap Growth VOT Vanguard Mid-Cap Growth ETF
LARGE VALUE VTV Vanguard Value ETF
MID-CAP VALUE VOE Vanguard Mid-Cap Value ETF
MID-CAP BLEND VO Vanguard Mid Cap ETF
SMALL BLEND VB Vanguard Small Cap ETF
Mid-Cap Growth VOT Vanguard Mid-Cap Growth ETF
Small Growth VBK Vanguard Small Cap Growth ETF
SMALL VALUE VBR Vanguard Small Cap Value ETF
MID-CAP VALUE VOE Vanguard Mid-Cap Value ETF
Foreign Large Blend EFA iShares MSCI EAFE Index
Foreign Large Blend VEA Vanguard Europe Pacific ETF
SMALL BLEND VB Vanguard Small Cap ETF
Foreign Large Growth EFG iShares MSCI EAFE Growth Index
Small Growth VBK Vanguard Small Cap Growth ETF
Foreign Large Value EFV iShares MSCI EAFE Value Index
Foreign Small/Mid Value SCZ iShares MSCI EAFE Small Cap Index
SMALL VALUE VBR Vanguard Small Cap Value ETF
DIVERSIFIED EMERGING MKTS VWO Vanguard Emerging Markets Stock ETF
Foreign Large Blend EFA iShares MSCI EAFE Index
REAL ESTATE VNQ Vanguard REIT Index ETF
Foreign Large Blend VEA Vanguard Europe Pacific ETF
Global Real Estate VNQI Vanguard Global ex-US Real Estate ETF
COMMODITIES BROAD BASKET DBC PowerShares DB Commodity Idx Trking Fund
Foreign Large Growth EFG iShares MSCI EAFE Growth Index
Commodities Precious Metals IAU iShares Gold Trust
Foreign Large Value EFV iShares MSCI EAFE Value Index
SHORT GOVERNMENT SHY iShares Barclays 1-3 Year Treasury Bond
Foreign Small/Mid Value SCZ iShares MSCI EAFE Small Cap Index
LONG GOVERNMENT IEF iShares Barclays 7-10 Year Treasury
DIVERSIFIED EMERGING MKTS VWO Vanguard Emerging Markets Stock ETF
Intermediate Government IEI iShares Barclays 3-7 Year Treasury Bond
REAL ESTATE VNQ Vanguard REIT Index ETF
Intermediate-Term Bond BND Vanguard Total Bond Market ETF
Long-Term Bond LQD iShares iBoxx $ Invest Grade Corp Bond
Global Real Estate VNQI Vanguard Global ex-US Real Estate ETF
Short-Term Bond CSJ iShares Barclays 1-3 Year Credit Bond
COMMODITIES BROAD BASKET DBC PowerShares DB Commodity Idx Trking Fund
Intermediate-Term Bond CIU iShares Barclays Intermediate Credit Bd
Commodities Precious Metals IAU iShares Gold Trust
High Yield Bond HYG iShares iBoxx $ High Yield Corporate Bd
SHORT GOVERNMENT SHY iShares Barclays 1-3 Year Treasury Bond
Inflation-Protected Bond TIP iShares Barclays TIPS Bond
LONG GOVERNMENT IEF iShares Barclays 7-10 Year Treasury
WORLD BOND WIP SPDR DB Intl Govt Infl-Protected Bond
Intermediate-Term Bond VMBS Vanguard Mortgage-Backed Sec Idx ETF
Intermediate Government IEI iShares Barclays 3-7 Year Treasury Bond
WORLD BOND BWX SPDR Lehman Intl Treasury Bond
Intermediate-Term Bond BND Vanguard Total Bond Market ETF
Emerging Markets Bond EMB iShares JPMorgan USD Emerg Markets Bond
Long-Term Bond LQD iShares iBoxx $ Invest Grade Corp Bond
Short-Term Bond CSJ iShares Barclays 1-3 Year Credit Bond
ROOT CASH CASH
Intermediate-Term Bond CIU iShares Barclays Intermediate Credit Bd
High Yield Bond HYG iShares iBoxx $ High Yield Corporate Bd
DIVERSIFIED EMERGING MKTS DEM WisdomTree Emerging Markets Equity Inc
Inflation-Protected Bond STPZ PIMCO 1-5 Year US TIPS Index ETF
Inflation-Protected Bond TIP iShares Barclays TIPS Bond
Inflation-Protected Bond LTPZ PIMCO 15+ Year US TIPS Index ETF
WORLD BOND WIP SPDR DB Intl Govt Infl-Protected Bond
Short-Term Bond VCSH Vanguard Short-Term Corp Bd Idx ETF
Intermediate-Term Bond VMBS Vanguard Mortgage-Backed Sec Idx ETF
WORLD BOND BWX SPDR Lehman Intl Treasury Bond
Short-Term Bond BSV Vanguard Short-Term Bond ETF
Emerging Markets Bond EMB iShares JPMorgan USD Emerg Markets Bond
LARGE BLEND VIG Vanguard Dividend Appreciation ETF
ROOT CASH CASH
LARGE VALUE VYM Vanguard High Dividend Yield Indx ETF
DIVERSIFIED EMERGING MKTS DEM WisdomTree Emerging Markets Equity Inc
Inflation-Protected Bond STPZ PIMCO 1-5 Year US TIPS Index ETF
Inflation-Protected Bond LTPZ PIMCO 15+ Year US TIPS Index ETF
Short-Term Bond VCSH Vanguard Short-Term Corp Bd Idx ETF
LARGE VALUE FVD First Trust Value Line Dividend Index
Short-Term Bond BSV Vanguard Short-Term Bond ETF
Intermediate-Term Bond BOND PIMCO Total Return ETF
LARGE BLEND VIG Vanguard Dividend Appreciation ETF
LARGE VALUE VYM Vanguard High Dividend Yield Indx ETF
LARGE VALUE FVD First Trust Value Line Dividend Index
Intermediate-Term Bond BOND PIMCO Total Return ETF
Click to enlarge

This is not an isolated case. In fact, the following shows the performance comparison chart between Cambria Global Tactical (NYSEARCA:GTAA), DWA Tactical (MUTF:DWTFX) and Vanguard 60% stocks/40% bond balance index fund VBINX:

Symbol 1 Yr 3 Yr 2012 2011 2010 2009
GTAA 4.1 NA 4.9 -7.3 2 NA
DWTFX 7.1 6.8 5.5 -7 12.5 23.6
SPY 34.3 14.3 16.9 1.9 14.6 26.4
VBINX 21.6 11.1 10.9 3.6 13.1 20.1
Click to enlarge

In 2009, 2010 and 2012, the buy and hold portfolios have done better than actively managed tactical portfolios while in 2011, the tactical also lagged the US stock and bond balance fund such as VBINX.

So should one write off the tactical strategies again? Should investors become complacent and satisfied with strategic asset allocation? Well, it depends. If you look at more closely how the two types of allocation strategies behaved in the past, you will find that both strategies complemented with each other at different times.

First, if you look at longer term performance, tactical portfolios did perform better, especially in 2008 and 2001-2002. This is not surprising as tactical allocation tries to step through a bear market more carefully.

Secondly, the tactical portfolio usually lags in early bull markets (or in the phase of strong recovery out of bear market low). It then gradually catches up and eventually outperforms in the late stage of the bull market. For example, the tactical portfolio here did better than the two strategic portfolios from 2001 to 2002. It then lagged behind from 2003 to 2004. It caught up and outperformed again in 2005 to 2007 and then it did better again in 2008 (the bear market). It then underperformed again from 2009 to present.

The intuition behind this behavior is clear: in the initial phase of a bull market, the buy and hold equity portions in a portfolio contributes significantly to the upside, while in a tactical portfolio it slowly adjusted its risk asset exposure. In the middle of a bull market, secular trends are forming with trial and error attempts, and this results in the tactical portfolio's underperformance also. In the late bull market, all trends are set up and the tactical portfolio will ride on the strongest asset trends, which results in stronger performance. Finally, in a bear market, tactical portfolios reduced risk asset exposure, resulting in less loss.

From the above discussion, it is clear that strategic and tactical asset allocations should be complemented with each other. It is not an "all or nothing" or "either you or me" binary choice. This is consistent with our previous position in core satellite portfolios.

Disclosure: I am long SPY, GLD, TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.