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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

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

Today 2015 2020 2025 2030

one year returns are volatile
One-Year Returns Are Volatile

Models incorporate standard deviation to manage risk

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 study1
DeMarche Supercycle Study

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

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
slide18

Asset Allocation – Expected Returns

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

Source: DeMarche Associates. See notes on next slide.

slide19

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
slide21

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
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
slide24

Example of TDF Asset Allocation

Fewer equities as participant retire date nears

Source: PIMCO, compiled by MarketGlide.

slide25

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
slide29

Questions?

Thank you!

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