Subscribers to our Tactical Strategies ETF-based model portfolios continue to have more options to keep costs down while pursuing our quantitative model-driven tactical asset allocation strategies. More at: parmodel.com/for-investment-advisers/tac.../

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

As purveyors of TAA - tactical asset allocation - research, we completely agree that there should be the opportunity for improving the risk-return profile of investors through actively managing one's major asset class allocations over time. What the article gets correct is that this is very difficult to do, and something most mutual fund managers have proven not to be adept at. The approach can certainly not be based on simply tracking one or two indicators or following a trend. You can read all about our approach at parmodel.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Why pay high HF fees for no discernible advantage? Our approach with the PAR Model research service and our MCM Tactical Strategies, is to utilize highly-liquid, cost-effective ETFs combined with our proprietary, quantitative approach to asset allocation to help investors of every size improve their risk-return profile without the high fees. parmodel.com

Our model-based Stocks-Bonds strategy returned 18.8% in 2012, outperforming the 60/40 benchmark by 9.3%. The Stocks-Cash strategy outperformed by 5.5%.

1. How Strategies Work

We track tactical asset allocation/Benchmark Timing strategies that are based on PAR Model™ equity return forecasts. The exposure to the S&P 500 (SPY) is based on the model's return forecast. If the forecast is positive, the portfolio is invested in the equity index; if it is negative, it is invested in a low-risk asset class - bonds or cash.

The chart below presents the PAR Model's™ out-of-sample historical results since its inception in 2002. Buy and Sell signals indicate when the return forecast changed sign, which is when the model recommended buying or selling equity index.

(click to enlarge)

In 2012, the PAR Model™ gave a Sell signal on Feb 29th, and a Buy signal on Jun 30th. Not perfect timing, but reasonably good - within a month of the peak and the trough.

Two strategies are presented here: Stocks-Bonds(IEF) and Stocks-Cash. Both strategies switch 100% of portfolio to one of the two asset classes, based on the PAR Model's™ Buy or Sell signal. No leverage is used. Performance is presented starting from strategy inception on January 1, 2002, and for 1y and 5y periods (risk and IR are for 5y). Performance is net of average transaction costs of 0.1% bid-ask spread for stocks and 0.2% bid-ask spread for bonds.

Because most investors hold a balanced stock-bond portfolio, we use a benchmark that consists of 60% stocks and 40% bonds, rebalanced monthly.

2. Performance

(click to enlarge)

Both strategies performed very well in 2012, based on our real-time reporting of PAR Model™ results to clients. The Stocks-Bonds strategy returned 18.8% in 2012, outperforming the 60/40 benchmark by 9.3%. The Stocks-Cash strategy outperformed by 5.5% in 2012. Over five years, the two strategies outperformed the benchmark by annualized 21.7% and 15%, respectively.

3. Risk and Information Ratio

The Stocks-Bonds strategy adds 3.8% to annual volatility, while the Stocks-Cash strategy adds 3%. However, both strategies reduce downside risk (drawdown) by half relative to the 60/40 benchmark.

The Information Ratio is above 1.8 for the Stocks-Bonds strategy, and 1.4 for Stocks-Cash. These levels of IR indicate a high level of skill, and are typically consistent with top-decile manager performance.

Disclosure: I am long [[SPY]].

While equities sold off, the factors that matter for determining future equity return, according to our PAR Model™, have improved significantly since September:

• Individual investor sentiment, according to AAII, is now at panic level, with the ratio of bearish to bullish investors rising to over 1.5. This is a contrary indicator - high bearishness typically precedes a rising market.
• The drop in oil price to $85 is also very positive for the model's return forecast (the Energy sector notwithstanding).
• Economic and valuation factor data improved as well.

Driven by these improvements in the data, the PAR Model™ gave its highest forecast since August 2010. The actual 6m total return was 27.7% from that point. Forecasts do involve a forecasting error, and one may not expect return as high as that, but the expected, most likely scenario return still looks very attractive.

Don't take us wrong - we consider the deficit and debt to be a real and serious problem. But should we really be more scared than 2,3, 5 years ago, when it was about the same, but NO one even mentioned it? Ironically, because people are now concerned about it, and it's being discussed in top politics and broadly in the media - that's why something will be done about it, and it will improve. Once the solution is found, the markets, in their bipolar way, will view it as positive.

With the latest model result, we are issuing a Significant Overweight equity recommendation, which is our most positive stance. Managers who follow a strategy of adjusting their positions based on the strength of the forecast are advised to increase the overweight. Fortunately, the market seems to present an excellent opportunity to do so after the recent drop.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Portfolio returns in excess of an index can be achieved through active investment management in two ways: security selection, and active (or tactical) asset allocation. Research shows that about 90% of a typical balanced stock-bond portfolio risk and return comes from Policy asset allocation - see Brinson et.al. (1986, 1991), Ibbotson & Kaplan (2000). Clearly, potential for adding value through actively managing asset allocation is greater than from active security selection. However, while active security selection is widely practiced, tactical asset allocation (TAA) has been largely overlooked or out of favor. Here, we discuss some of the reasons for this, and describe the process that should be followed in order to successfully perform TAA.

read full article here: http://parmodel.com/1170/

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.