Theoretically, we all know that when it comes to investments, we need to set reasonable expectations from the stock market based on our risk appetite and other macro/micro factors.
Who among us hasn’t woken up and checked their portfolio to see if their investments have increased? The mind understands that we need to understand the volatility in the stock market and the potential returns that can be derived through investment in the stock market.
What if you could allocate your portfolio depending on the market condition depending on the scenario that’s prevalent?
Tactical Asset Allocation can help you with just that. How? Let’s find out!
Understanding Tactical Asset Allocation
As the name suggests, Tactical Asset Allocation is one of the ways that helps adjust a portfolio’s asset mix in response to changing market conditions.
It’s a more fluid approach, as you may consider. Nothing is set in stone over here ie we all know the dynamics of the ever-changing stock market; one needs to be well-read and do proper research in order to keep adjusting the portfolio allocation depending on how the market reacts.
Imagine, for instance, that you assume that you’ve created a well-balanced portfolio for yourself, with a primary concentration of large-cap stocks.
Now, your portfolio is probably the way you expected, and it’s doing well. But you want more. What you can do is set aside a certain amount that you can invest more tactically, isn’t it?
What does this mean?
Well, let’s say, for example, that the fintech sector is starting a bullish run. You have a couple of large banking stocks in your portfolio already. But you want to invest in a few other companies coming up in the investment space.
Remember, investing in sector-specific stocks can be risky. The fund manager may or may not invest in the sectors mentioned herein.
Setting aside a fraction for tactical allocation helps you to do just that. In a way, you may consider not selling off any of your long-term investments.
Your strategic asset allocation remains undisturbed. Instead, you make extra investments in some mid-caps in the BFSI space, aiming for potential returns. Be aware that midcap investments carry very high risk. Ensure you understand these risks and consider consulting a financial advisor before investing. This can be for the short-term or long-term, depending on your investments. It is always advisable to keep watching over your portfolio.
But that’s the beauty of tactical allocation. You have the flexibility to alter your investments whenever you want.
Some of the Principles of Tactical Allocation
Flexibility
This is the concept on which the tactical asset allocation is based. You need flexibility in order to adjust your portfolio.
It doesn’t mean you need to switch up your entire portfolio. But at least a portion of it needs to be dynamic, but as stated above, we should have the knowledge and be aware that investments in the stock market are volatile and consist of high to very high risk also. Thus, you may consider consulting your financial advisor before investing
Market Analysis
This is a prerequisite. You need proper and rigorous market analysis in order to capitalise on macroeconomic trends, interest rates, corporate earnings, geopolitical events and the like.
Risk Management
Now, tactical asset allocation is not just about seeking to increase your potential returns. Often, it is also used as a hedging and risk management technique.
For example, you notice a particular sector is booming. While it might be tempting to invest heavily in that sector, it’s important to remember that what goes up can come down. By diversifying your investments across different sectors, you can reduce the risk of losses if one sector takes a hit. This is done so that your overall portfolio remains balanced and less vulnerable to market swings.
Tactical Asset Allocation in Mutual Funds
As you can imagine, tactical asset allocation is a strategy used to actively manage mutual funds. The objective here is to seek to generate potential returns for the portfolio.
Funds like dynamic asset allocation funds, or even multi-asset allocation funds use the concept of tactical asset allocation with an aim to increase potential returns to their portfolios. However, in order to understand the investment objective and strategy in depth and also the features and details about the Scheme, we suggest you read the Scheme Information Document about the Scheme to learn more details.
The fund managers, in this case, use a variety of indicators to gauge what the overall outlook of the market is, and try to understand which way it’s going to go.
For example, macroeconomic indicators like Gross Domestic Product (GDP) growth and interest rates can have quite an impact on investment decisions.
For instance, GDP growth is in line with the expectations, and inflation is within RBI’s acceptable limits. The market outlook is positive overall, and the fund manager decides to increase the equity allocation to take advantage of the anticipated growth in the stock market.
How?
They increase exposure to sectors like consumer goods, technology and others that are expected to benefit from the economic growth.
Similarly, if the market starts to anticipate that RBI will introduce a rate hike, the situation will change again. From optimistic, the mood will now change to cautious.
In this situation, the fund manager will decrease exposure to interest rate-sensitive sectors and increase allocation to sectors that benefit from higher rates like financials.
The fund manager may also go one step beyond and increase the allocation to short-term bonds to reduce interest rate risk.
What are the Challenges?
Tactical asset allocation seeks to offer numerous benefits for your portfolio. And one of the objectives is to help you provide potential returns.
Having said that, however, you must remember that this strategy does not come without risks.
- Market Timing
SEBI itself suggests that we should not try to time the market but instead make informed decisions.
Market timing is about anticipating changes and making the right calls before the tide turns. However, even for professional fund managers, this is much harder than it sounds.
It is very easy to go wrong when you’re playing with the edge of a knife, and any missteps can be disastrous. Incorrect investment decisions can lead to suboptimal performance and increased volatility.
For example, if the fund manager increases equity exposure just before a market correction, it may result in significant losses to the portfolio!
- Higher Costs
Tactical asset allocation involves active management. You need to keep buying and selling shares and rebalance the portfolio frequently.
This may lead to higher transaction costs, expenses and taxes, which in turn, can erode your potential returns.
- Complex
Tactical asset allocation may sound simple, but implementing it is quite challenging. Fund managers rely on advanced models and tools, along with their expertise, to execute it effectively.
- Behavioural Biases
No matter how hard we try, there is some bias in our decisions. Fund managers, of course, are experts. But even then, behavioural biases creep in.
Now, in normal situations, this might not even matter.
But, when you’re attempting to beat the market, this can often lead to overconfidence or even herd behaviour. This, in turn, can have an impact on decision-making and performance.
Summing Up
Tactical asset allocation is powerful. But don’t go all out with it.
As with all other investment strategies, only go as far as you’re comfortable. With mutual funds, of course, you can explore tactical asset allocation in an investable manner.
Remember, TAA isn’t about becoming a millionaire overnight. It’s about being nimble, adapting to market conditions, and potentially enhancing your potential returns. But like a powerful sports car, it needs skilled handling. For most of us, a TAA mutual fund might be the equivalent of taking that sports car for a spin with a professional driver at the wheel.
Simply choose the fund you’re comfortable with and invest! Please consult your financial advisor before investing.
Don’t forget to track the performance of your portfolio with Dezerv’s wealth monitor!
After all, in the world of TAA, knowledge isn’t just power – it’s profit, isn’t it?
Frequently Asked Questions
What is the difference between strategic and tactical asset allocation?
Strategic/planned asset allocation refers to the long-term approach of your portfolio. This is based on your investment goals and your preferences, and this generally does not change too often.
But the markets are volatile and always changing. This is where tactical asset allocation comes in. You essentially reserve a small portion of your portfolio to take advantage of shorter market trends. You seek to capitalise on the opportunities as and when they arise.
What is the tactical allocation approach?
The tactical approach is a more active one. You track the markets and attempt to identify which sectors or companies may offer potential returns in the short term. The objective is to seek potential profits.
What is the difference between dynamic and tactical asset allocation?
Dynamic asset allocation is a completely volatile approach. You’re constantly switching between different stocks and sectors to optimise your portfolio.
However, tactical asset allocation is all about capitalising on short-term market trends. Essentially, you reserve a portion of your capital to generate potential profits.
Does tactical asset allocation add value?
Tactical asset allocation can certainly add a lot of value if utilised in the proper manner. But only if you do it right. It is advisable to reserve only a small portion of your assets for tactical allocation. For the remaining, we suggest you stick to your long-term investment goals or consult your financial advisor to know in detail, depending on your risk appetite.