Tactical asset allocation in bull bear markets
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Tactical Asset Allocation in Bull/Bear Markets. Timothy J. Marchesi, CFA President, CEO & Co-CIO DeMarche Associates, Inc. Agenda. Importance of Asset Allocation Tactical vs. Conventional Approach Economic & Market Environment Supercycles Dynamic Investment Strategies .

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Tactical Asset Allocation in Bull/Bear Markets

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Tactical asset allocation in bull bear markets

Tactical Asset Allocation in Bull/Bear Markets

Timothy J. Marchesi, CFA

President, CEO & Co-CIO

DeMarche Associates, Inc.


Agenda

Agenda

  • Importance of Asset Allocation

  • Tactical vs. Conventional Approach

  • Economic & Market Environment

  • Supercycles

  • Dynamic Investment Strategies


Importance of asset allocation

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 & Beebower

    2 Global Asset Allocation Techniques for Optimizing Portfolio Management, 1994 – Lummer & Riepe


Review of conventional approach

Review of Conventional Approach

  • Inputs based upon history

  • Typical models assume “average” future outcomes

  • Often ignore starting /ending market levels


Review of conventional approach1

Review of Conventional Approach

  • Typical models assume “average” future outcomes (sample chart below)

12%

10%

8%

6%

4%

2%

Emerging Equities

Small Cap Equities

Large Cap Equities

Hedge Fds

Bonds

Today2015202020252030


One year returns are volatile

One-Year Returns Are Volatile

Models incorporate standard deviation to manage risk


Model optimization the efficient frontier

Model Optimization:The Efficient Frontier


What is tactical

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


Time horizon for investment objectives

Time Horizon for Investment Objectives

Asset Allocation Study has both a strategic perspective and a long-term secular perspective

Investment Horizon

ShortTerm

Long Term

Tactical Asset Allocation

Strategic Asset Allocation

Secular Asset Allocation

Market Timing

Several Market

Phase Cycles

Multiple Market Supercycles

One Year Or Less

Current Market

Phase Cycle


Demarche market phases

DeMarche Market Phases

A typical market cycle has four distinct phases:

Stock

Stock

Corporate

Corporate

Total

Total

Tactical Market Phase

Tactical Market Phase

Prices

Prices

Earnings

Earnings

Return*

Return*

Phase I

Phase I

Early Bull

Early Bull

é

é

ê

ê

62.0%

20.8%

0.5%

-27.0%

Phase II

Phase II

Bull Market

Bull Market

é

é

é

é

Phase III

Phase III

Late Bull/Early Bear

Late Bull/Early Bear

ê

ê

é

é

Phase IV

Phase IV

Bear Market

Bear Market

ê

ê

ê

ê

*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


Markets change

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”


Demarche supercycle study

DeMarche Supercycle Study


Demarche supercycle study1

DeMarche Supercycle Study

*As of 3/31/2011. Cumulative returns are shown for each cycle (non-annualized).


Tactical asset allocation in bull bear markets

The Consumer in Supercycles


New normal macroeconomic environment

New Normal Macroeconomic Environment

  • Demographics

    • “Boomers” retire or shift emphasis from consumption to saving

  • Consumers gradually improve their finances

    • Paying down debt / increase savings


New normal macroeconomic environment cont d

New Normal Macroeconomic Environment (cont’d)

  • Unemployment

  • Wage growth remains slow

  • Less help from asset gains (wealth effect)

  • Higher taxes


Strategic implications of current supercycles

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


Tactical asset allocation in bull bear markets

Asset Allocation – Expected Returns

Next 5 Year “Strategic” Period versus Long-Term “Secular” Time Horizon

Source: DeMarche Associates. See notes on next slide.


Tactical asset allocation in bull bear markets

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.


Dynamic investment strategies

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


Tactical asset allocation in bull bear markets

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


  • Sample range of gtaa fund approaches

    Sample Range of GTAA Fund Approaches


    What is a target date fund

    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


    Tactical asset allocation in bull bear markets

    Example of TDF Asset Allocation

    Fewer equities as participant retire date nears

    Source: PIMCO, compiled by MarketGlide.


    Tactical asset allocation in bull bear markets

    TDF Glidepaths

    Programs reduce equities over time; some have tactical range


    Brief intro commodities

    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

    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 high yield emerging market bonds

    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)


    Recommendations

    Recommendations

    • Adjust asset allocation more frequently

    • Incorporate Supercycles

    • Emphasize liquidity

    • Diversify

    • Increase allocation to dynamic strategies


    Tactical asset allocation in bull bear markets

    Questions?

    Thank you!


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