65. Your Investment Approach: Strategic or Tactical
Your Investment Approach: Strategic or Tactical
The next step in building your own investment approach is deciding when you want to make changes to your asset allocation. Do you want to change when the market changes hoping to time the market (tactical) or do you want to maintain a steady allocation changing when your situation changes (strategic)?
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Transcript:
Hello, and welcome back to the Canadian Money Roadmap Podcast. I'm your host, Evan Neufeld. Today we're looking at our second episode in our series on building your own investment approach, and we're looking at strategic versus tactical portfolio management.
Well, if this is your first time joining us. Thanks so much for coming here and I'm looking forward to doing some more in this series. But if you're just getting started here, go back to a couple episodes ago and I'll do an intro to this series on building your investment approach. The whole idea here is that I want to give you as much information as you can to know exactly how you like to invest and how you can build a portfolio that matches that. And hopefully being able to look beyond simple dogmatic advice that you might have seen on the internet and actually know what the impacts are of that, and how that works with your preferences and goals.
So last week we looked at stocks and bonds and how each of those can play a part in a diversified portfolio. And now we're looking at how do you make changes to a portfolio and how do you actually set up that allocation. So this episode is about strategic and tactical portfolio management. So let me get started by explaining what each of those might be.
Tactical portfolio management would be the idea that you're changing your asset allocation. Again, that's your mix between stocks and bonds and many other asset classes. But let's just talk about stocks and bonds for the sake of this. That tactical management is changing that mix, with the hope of increasing returns and potentially decreasing risk. So for example, sometimes a tactical investor might own lots of stocks. So let's say they're an 80/20 investor when they really like stocks, and then when they think that stocks are in a poor time to own them, they might own maybe only 40% in their portfolio. And that ebbs and flows over time based on whatever their convictions are and their assessment of the market at that point.
Describing tactical management is very difficult because every person that tries to do it has a very different conviction and reasons why they might make changes. But if you just think about all the different factors that could come into that, you know, you could look at forward looking projections, you could be a momentum trader, you could look at different sectors, all those different things. A high level of tactical portfolio management really requires an involved understanding of the market pricing, valuation and even access to buy and sell asset classes that are typically not even available to the average person very easily. There's more and more ETFs and things like that that can be used to fit various different asset classes, but it is very challenging to do that at a really high level. And understanding markets, there's a lot more to it than watching CNBC or Bloomberg once in a while, or reading an article on the Globe of Mail, or even listening to podcasts like mine. It's possible to do tactical management with a simple strategy, I'm sure, but changing your portfolio based on a single hunch is a great way to lose money, especially over time. You might get it right, I guess. But yeah, buying stocks or sectors that have done well recently is also more like performance chasing than actual tactical management, in my opinion. So this is a really, really difficult way to actually run your portfolio, but people that are interested in markets and investing, they often have ideas about what they think might be coming down the pipe in the investing world, and they might want to adjust their portfolio to reflect that. So kind of like I mentioned before, this could look like moving in and out of specific sectors or following trends. Trend investing is, I've seen a lot of comments about that online and momentum investing, we talked about that back in our factor investing series I did with Jordan late last year. So I'll talk a little bit more about tactical again here in a second. But that's just kind of a high-level overview of what tactical portfolio management is.
Now strategic, on the other hand, is mostly a static, meaning not changing allocation of stocks and bonds that it generally just doesn't change much over time. And market performance will adjust that allocation. So if we assume that stocks generally outperform bonds more often than not, If you have a 60/40 portfolio, eventually over time if you just leave it, it'll start looking like a 70/30 just because the stocks have increased in value by a bit more. So rebalancing is required to get back to neutral unless you're using what we call an asset allocation ETF or mutual fund. That'll do that automatically in the background for you. That's a really great way to do strategic portfolio management in my mind, is to invest in tools that will do any of that guesswork for you. When it comes to making changes with a strategic portfolio. I would often recommend that the idea is that you'd want to change your strategic allocation when your life changes and when your risk profile changes. So some periods of time that you might think of would be retirement. That's an easy one to think of because you're going from an accumulation mode to a de-accumulation and you're actually living off your portfolio. Most people would end up taking a little bit less risk with their portfolio at that point. So say you're a hundred percent stock investor as you are accumulating. Now when you're in a de-accumulation stage, you might not be as comfortable taking that much risk with your portfolio, so you could change your strategic allocation based on your life circumstances, which has nothing to do with what's going on in the market. Has nothing to do with what you think is coming in terms of interest rates or inflation or earnings or anything like that. It's based on your situation. So tactical allocation will change based on market moves and anticipation of things going on there in the investment markets and strategic allocation changes when your life changes.
So let's take a look at some of the potential benefits of each of these. So some benefits of tactical portfolio management, theoretically. Most of these are theoretical because there's ways to do it right and that's usually determined in hindsight, I guess. So some theoretical benefits of tactical portfolio management would be the ability to reduce volatility. So if you're a believer in following trends and perhaps when the market starts going down, you're a believer that it'll keep going down. Well, if you reduce your stock exposure at that time, then your volatility overall will decrease. Great in theory, in practice that's probably a lot harder to do than you'd expect. But you know, taking advantage of trends is another benefit of tactical management. So even things like in 2020 the stay-at-home stocks. Those were things that just kept going and going and going. And so if you could get on that train early enough, you could really make some money. So taking advantage of trends can be a way to increase returns. Again, theoretically, because it's really hard to do. But if you can do it, it can work.
The third benefit of tactical management is more psychological than anything because a lot of people feel like they want to take action if they're looking at their portfolio, if they're reading the news, the benefit of taking action is largely psychological or it feels good to do something instead of sitting on your hands.
I would try to argue that generally works against you , but lots of people like that benefit. And so if you're a person that really feels like you're called to action within your portfolio, a tactical approach is probably one that that might be decent for you.
So on the other side, some potential benefits of strategic portfolio management. It's very simple and there's very few decisions required. And so for people that are keen on the idea of passive income and passive investing, again, tactical and strategic isn't active and passive, and they will overlap here. But next week I'm going to talk about active and passive. But you'll hopefully be able to see the difference. But using a strategic approach is very simple because you, you essentially only have to decide when to rebalance and when to change your allocation. So there's a lot more research and evidence that says that perhaps a strategic allocation could outperform because a human error is less likely to get in the way. To me this makes sense, right? If you've ever placed a bet on a football game or a basketball game or something like that, it's like, man, even when you think you know exactly what's going to happen, very often it is hard to predict outcomes. Like even if we go back to the World Cup. Argentina, the eventual winners of the World Cup, they lost to Saudi Arabia in their first game.
Like no one, saw that coming. And you know, as one of my favorite authors, Morgan Housel says, things that have never happened before happen all the time. And so using a strategic approach generally limits your exposure to some of those outsized events one way or another, because you wouldn't be necessarily overexposed to any one risk at any given time. You've kind of based it on your risk profile as opposed to market conditions or anything like that. So because of the simplicity of a strategic approach, it is often lower cost because costs are incurred by additional trading, additional research, additional this, that, and the other thing. If there's fewer decisions, fewer trades that need to be made, generally speaking, a strategic approach can be a lower cost. Now, before I go into a couple examples of each and how each of those can be beneficial in terms of good outcomes. When we look at strategic or tactical, depending on which approach feels best to you, you can implement it in a couple of different ways. So you can be the one to do the tactical shifts, or you can be the one to set up the strategic allocation, or you can offload that either via a financial advisor or through an investment manager. So the investment firm or the product itself will do the tactical allocations for you behind the scenes, or they will set up the strategic allocation for you behind the scenes. And the examples that I'll give here are examples of that. So last week I gave some examples using some Vanguard ETFs. Most of you would be familiar with Vanguard and today I'm going to look at a different company. Just try not to show favoritism to any one company necessarily. But I'll give you two examples of a strategic and a tactical portfolio each from Fidelity investments and full disclosure, these are real funds that are available. And some of my clients have exposure to these funds. I'm trying not to pick and choose here. So these are real ones that I know and am familiar with and have used with clients. But that doesn't necessarily mean that they would be perfect fits for you. But I just wanted to give these as examples of tactical portfolio that has performed well and a strategic portfolio that has performed well too. So let's start out with the tactical one. So, Fidelity's tactical high-income fund is a balanced fund, meaning it's a combination of both stocks and bonds and it has been around since 2014. But I'm going to be using Morningstar here to take a look at some full periods of time, and they do a 1, 3, 5, and 10 year period. So five years is the longest that I can look at here, but over the last five years, which encompasses both Covid and last year with the big declines in both stocks and bonds. The last five years would be a pretty good time to evaluate the differences between tactical and strategic based approaches. So in this tactical fund, the neutral mix is pretty close to a 60/40. However, over the course of this fund's existence, it has gone as low as 20% stocks as well. So this is all over the place and they use a lot more underlying asset classes within fixed income and within equities. So this fund changes a lot. And the way to take a look at that using Morningstar here is we take a look at turnover.
And so the turnover percentage for this fund is 171%. So what that means is a hundred percent turnover means that every year, every holding is sold and something else is bought and a 200% turnover would mean that it happens every six months. And so in this case here, 171%, I don’t know if someone else can do the math there, but let's call it every eight months every holding is changing over. So this thing is moving around a lot but still always a combination of some stocks and some bonds, but it's changing based on what the market is presenting in terms of opportunities. So how does that actually play out? Well over a five-year period of time, the index here, so a relative balanced fund returned about 4%, so 4.05, whereas this fund has returned 8.6% per year over the last five years. So it's over double the index. And since there are fees associated with this investment. The 8.6% I mentioned for returns there are after all fees have been accounted for. And this is what many on the internet might call a high fee mutual fund for sure. The fees on here are not cheap and they don't try to be, they're trying to deliver a specific approach and there are additional costs that come along with.
So now from a risk standpoint, the idea with tactical portfolio management is that theoretically it can actually reduce risk compared to a static allocation. And so then over the last five years, the returns have been double. And going back to last episode, I introduced that idea of standard deviation. So standard deviation isn't a perfect metric for risk, but it's pretty decent in terms of evaluating how volatile it is. Meaning how much does a price change from day to day or year to year. And so for this fund, it has a five year standard deviation of just over seven, so 7.17, whereas the index has a standard deviation during that same period of time of 8.3.
So this is interesting. It's kind of like a unicorn investment in a way, right? So it's actually been lower volatility with higher returns. Can we assume those will continue indefinitely into the future? Absolutely not, Right. That's always the challenge with tactical portfolio management, so you can look at something that has performed well in the past. The problem is we never know if it's going to do exactly the same in the future, and we can be relatively confident that it won't be, but if we're just looking with, just with hindsight here, this tactical portfolio has delivered what tactical management intends to do. Hopefully increased performance while decreasing risk. And so yeah, the managers here have done a really good job. This is the top performing fund in the tactical balance category. Again, this is the Fidelity tactical high income fund.
So if you're someone that really does want to make a lot of changes to your portfolio, but you don't have the knowledge or the access or the time or the temperament to actually do that, using a mutual fund manager or group of managers in this case to do that tactical approach for you could be a decent idea.
Again, I'm not recommending that fund specifically, but you could talk to your investment advisor to find something that's at least similar that kind of matches your investment philosophy.
So now on the strategic side of things, Fidelity also has a strategic portfolio. There are many of them of course, but this one is called the Fidelity Global Balance Portfolio. This is one of their largest funds. There's about $12 billion in this fund, and it has been around for quite a while. And so this one is a 60/40 fund and it will move a little bit. But the turnover on this one isn't 171% like the tactical fund. This is a 23% turnover. So the holdings are turning over here on once every four years as opposed to twice a year. And this one has a neutral mix of 60/40, and I think it can go about 10% in either direction. And they'll try to rebalance it from time to time. They'll take advantage at the margins of perhaps some outsized opportunities. Maybe they'll be slightly tactical, but that's not the designed approach for this fund. And so let's take a look at the same period of time, perhaps just to compare apples to apples. So that same index. Over the last five years, there's about 4%, so just over 4.05. So that we're comparing against the same index here. This is a, hopefully a fair fight or a fair comparison. But this fund has returned 4.6% per year. So again, it has outperformed the index over a five-year period of time. This fund has been around longer, so it has outperformed over a 10 and a 15 year period of time as well after fees. But again, we'll just talk about the five year here. So 4.6% is quite a bit lower than the tactical approach that we saw on the other one of 8.6%. So, over the last five years, perhaps a strategic approach hasn't always been the best way to maximize returns but it's still done okay. Now, on a five-year basis, the risk there is a little bit higher than the index of about 8.8, compared to the index of 8.3. And so everything that in theory here when I use these two portfolios kind of makes sense. However, the people that invested in the balanced portfolio, they knew exactly what they were getting, they knew exactly what their allocations were, and then going forward, you kind of know exactly what you're getting to in terms of that 60/40. Of course, there's many other ways to set up your 60/40 if this is your case and you wanted to use passive tools behind the scenes, but that'll be more as a topic for next week episode on active versus passive. So these were two funds. Again, I didn't want to necessarily make it about Fidelity or make it about these two funds specifically, but the case of these two funds that I'm familiar with, both of them have done very well relative to the index. and those of you that would be completely skeptical on a tactical approach. There are funds out there that have done really, really well. The caveat is always, that we never know what the future holds. And so the appeal of tactical is the idea that it'll continue on outperforming at a lower risk forever and ever and ever. And that is very, very unlikely to be the case.
So, just to summarize, the two different styles that you might want to take a look at for your portfolio would be a tactical or a strategic style of portfolio management. And tactical is the idea that you're going to change the portfolio based on market conditions or what you're seeing on the news or what prices are for different asset classes in the hopes of increasing returns and decreasing risk. Whereas strategic allocation is the idea that you want to keep things relatively similar based on your risk profile and not necessarily taking advantage of opportunities that you might be seeing in the market. Market performance will adjust that allocation over time. So you'll have to do some rebalancing with strategic. So if you like the idea of moving things around based on what's changing in the markets, a tactical approach might be good for you. If you don't care what's going on in the markets and you just want to participate and make some money over a longer period of time, strategic allocation is probably a good option for you. Now, next week we're going to be talking about active versus passive, and I think there are two layers of active and passive that we can take a look at. I'm excited to talk about the ins and outs of that debate here a little bit more. But thanks so much for listening. If this was interesting for you, consider hitting follow and catching us on the next episode as well. Either way, thank you so much for joining me and I'll see you in the next episode.
Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal, and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.