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Strategic asset allocation (SAA) is the predetermined distribution of assets in a portfolio based on long-term goals and is established in an investment policy statement (IPS). On the other hand, tactical asset allocation (TAA) involves making short-term adjustments to the SAA, typically for capitalizing on specific market opportunities. These adjustments are temporary and usually last for up to one year.
Tactical asset allocation (TAA) primarily aims to enhance risk-adjusted returns. Competent portfolio managers utilize TAA strategies to mitigate risk during market volatility or exploit market anomalies to achieve additional returns. The following examples of TAA approaches may be familiar to level III candidates who have already been exposed to different investment styles.
This approach relies on the manager’s judgment and analysis. Macroeconomic variables such as forecasted GDP, inflation, and risk premiums are considered to identify potential short-term mispricing of securities or asset classes. For instance, if a manager anticipates a larger-than-expected decrease in inflation in the coming year, they may increase the portfolio’s allocation to fixed income. The investment policy statement (IPS) sets predefined ranges or limits on the extent of asset class shifts allowed for TAA. For example, the manager might have the flexibility to deviate up to 15% from the strategic asset allocation (SAA) to capitalize on perceived opportunities.
Market sentiment is another form of discretionary TAA in which a manager attempts to time the market by following a trend.
In contrast to the qualitative approaches discussed earlier, quantitative approaches typically rely on employing models to make investment decisions. These models generate binary recommendations: either to invest or not to invest based on predefined criteria.
Methods for evaluating the success of a tactical asset allocation (TAA) decision may include:
Question
Which of the following is least likely a qualitative approach to TAA?
- Following open interest.
- Using volatility indexes.
- Adopting a value bias.
Solution
The correct answer is C.
A value-based decision involves buying stocks in a specific sector when their market price is lower than the value indicated by the advisor’s model. Adopting a value bias is the least likely to be considered a qualitative approach to TAA. A value bias entails quantitatively analyzing fundamental factors and valuation metrics to identify undervalued stocks or assets. It focuses on objective criteria rather than subjective or qualitative factors. Therefore, option C is not a qualitative approach to TAA.
A and B are incorrect: Qualitative approaches to TAA include following open interest and using volatility indexes. Unlike value tilt, which allows for clear buy and sell decisions based on objective criteria, these qualitative approaches rely more on subjective analysis. They may not provide definitive guidelines for trading actions.
Asset Allocation: Learning Module 5: Asset Allocation with Real-World Constraints; Los 5(d) Discuss the use of short-term shifts in asset allocation