There is no consensus on what defines a “strategy” for asset allocation, but I know it when I see it. But on Wall Street and beyond, the details vary widely, so that two investors chatting about the topic could be citing radically different views. Point out an invitation to offer some thoughts on the underlying assumptions of strategic asset allocation strategies.
Strictly speaking, it is tempting to describe the strategy as anything other than a buy-and-hold strategy. But this is a step too far. If you start with a 60% stocks/40% bonds portfolio, and rebalance it to hit a one-time or year-end weighting, for example, I don’t see that as a tactical strategy. Rather, it strikes me as a simple risk-adjusted portfolio.
Sure, the lines can blur, but to me a strategy is a strategy that actively (we can argue definitions here too) seeks to generate risk and return results that are materially different from a passive (or lightly balanced) benchmark. This is a gray area, but a mechanical return to target weight doesn’t seem like a strategy to me. One important reason: no analytics are required, and no formal forecast is embedded in the balance. Instead, the decision is to realign the portfolio to a set of target weights.
In contrast, a strategy that relies on a model to predict risk and/or returns at some level, and then uses those predictions to balance, is a strategy. In contrast, a simple balancing strategy is free of forecasting and instead relies entirely on current data.
Strategy, then, requires some degree of ex ante analysis, while balance is an ex post exercise. Granted, balancing weighting assumes that a change in weighting will lead to higher future results, but a change in portfolio weighting is driven entirely by reviewing current portfolio data, perhaps in the context of calendar history (ie, a fixed period of time has passed).
So far, so good. On this basis, the definition of tactical versus non-textual is clear. But once we step into the strategy space, re-weighting assets based on some previous basis opens up a world of variations. It also brings us into the realm of blurring the distinction between strategy and strategy.
At a high level, it’s easy to distinguish between the two: strategy is short-term, strategic focuses on a medium- to long-term perspective. How do you distinguish between long and short horizons? Minds will differ, but as a basic measure I don’t see the strategy as a target for more than three years. Anything beyond that is strategic in my opinion.
Note also, that strategic, as opposed to tactical, comes in two types: passive or active. Differentiating variable: Is there a strategic balance based on current data or a predetermined calendar date, or is the former part of the analysis part of the mix?
It’s easy to see how definitions can blur, but this is only a problem from an academic perspective. An investor need not worry about whether his strategy has a tactical, strategic, or passive bias. Rather, results are all that matters.
What, then, is the approach to getting into the weeds that is tactical, strategic or passive? Basically, it’s a matter of deciding what’s best for your investment strategy, and understanding how the differences will affect results.
Choosing between a tactical, strategic, or passive investment strategy will affect risk and return. At this point, there can be no debate. The only question is how much control do you want over those outcomes, and how much risk are you willing to take to achieve a given outcome? Improving the odds that you will achieve your goal begins with understanding the pros and cons of how different professional strategy definitions differ.