Asset allocation strategies are a frequently discussed topic with increasing importance in times of crisis. Such strategies should prevent us from price deterioration in bad times and ensure high return potentials in good times. More and more tactical asset allocation funds emerge and promise better returns than simple strategy funds. They always try to be on the right market side, in up as well as in down phases. This seminar paper deals with some basic question about what strategic and tactical asset allocation is, when should it be used and if these strategies are appropriate in a highly uncertain environment like the current. It should give the reader a broad overview about the topic by referring to different accepted theories and studies. First the development of asset allocation methods will be described resulting in strategic and tactical asset allocation and an evaluation of them. Furthermore a link toward uncertain market conditions will be compounded.
Table of Contents
1. Introduction
2. Development of Asset Allocation Methods
3. Description of Strategic Asset Allocation
4. Description of Tactical Asset Allocation
4.1. Elemental Shifting Rules
4.2. Portfolio Insurance
4.3. Best of n risky assets
4.4. Protect Spending
4.5. Distinction between Strategic and Tactical Asset Allocation
5. Strategic versus Tactical Asset Allocation
5.1. Evaluation of Strategic Asset Allocation
5.2. Evaluation of Tactical Asset Allocation
5.3. Which Asset Allocation Decisions does affect returns most?
6. Asset Allocation under High Uncertainty
6.1. The Difficulty of Forecasting
6.2. The Importance of Risk and Correlation
6.3. Taking Inflation into Account
7. Conclusion
Objectives and Topics
This seminar paper explores the fundamental differences and potential synergies between strategic and tactical asset allocation, specifically examining their performance and suitability in highly uncertain market environments. The research aims to clarify whether active management through tactical strategies provides genuine value or if strategic frameworks remain the more reliable foundation for long-term investors.
- Theoretical foundations of asset allocation methods
- Distinction between Strategic (SAA) and Tactical Asset Allocation (TAA)
- Quantitative evaluation of portfolio performance strategies
- Impact of forecasting, risk, and correlation in uncertain markets
- Role of inflation in defining asset allocation scenarios
Excerpt from the Book
6.2. The Importance of Risk and Correlation
Variances and thus correlations between different assets do change over time. This is a crucial point since diversification is mainly build up on correlation assumptions. Markowitz already used correlations in 1952 to find the best mix between stocks and bonds (see Figure 1). The question of interest is which correlations should be assumed to calculate the optimal combination of different asset classes. The effect of correlation of course influences both, SAA and TAA, but it should generally be more important for TAA as long as it is more concerned about security selection. I want to present the most important aspects about correlation based on the work of Jacquier and Marcus in 2001 in this chapter.
Correlations can vary dramatically even within shorter periods. It is not unusual that correlations between two assets changes between 0 and 0.8 several times a year. There exists one phenomena called “correlation breakdown” which describes that correlation is weakest accurate when it is most desired. So correlation increases when the standard deviation of the market (e.g. NYSE Index) increases. The overall volatility of an asset consists of both, systematic and sector specific or idiosyncratic risk. Correlations between assets, even if they are of another sector or country depend on the systematic risk. As the uncertainty in macroeconomic factors increase the proportion of systematic risk measured to overall risk of the asset increases. Thus the correlation between assets must also accelerate. Nevertheless correlations must be predicted somehow to calculate the possible diversification effect between asset classes. Jacquier and Marcus (2001) evaluated the following five prediction methodologies:
Summary of Chapters
1. Introduction: Presents the relevance of asset allocation in times of crisis and defines the scope of comparing SAA and TAA strategies.
2. Development of Asset Allocation Methods: Reviews the historical evolution of portfolio theory starting with Markowitz's mean-variance model.
3. Description of Strategic Asset Allocation: Defines SAA as a long-term investment policy based on risk preferences and stable asset mixes.
4. Description of Tactical Asset Allocation: Explains TAA as an extension of SAA focused on day-to-day decisions, monitoring, and specific shifting rules.
5. Strategic versus Tactical Asset Allocation: Evaluates the performance of both approaches through quantitative studies, including Sharpe and Information ratios.
6. Asset Allocation under High Uncertainty: Analyzes the challenges of forecasting, correlation breakdowns, and inflation impacts on asset management.
7. Conclusion: Synthesizes the findings, suggesting a symbiosis of both strategies while emphasizing the importance of investor-specific risk and time horizons.
Keywords
Strategic Asset Allocation, Tactical Asset Allocation, Mean-Variance Model, Portfolio Insurance, Correlation, Market Uncertainty, Forecasting, Sharpe Ratio, Information Ratio, Inflation, Asset Classes, Diversification, Risk Management, Investment Policy, Financial Crisis
Frequently Asked Questions
What is the core subject of this paper?
The paper examines the concepts and differences between Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA) within the context of modern investment management.
What are the primary themes discussed?
Key themes include portfolio theory, the effectiveness of active versus passive strategies, the impact of market volatility on correlations, and the challenges of inflation and forecasting.
What is the primary research objective?
The objective is to determine whether tactical asset allocation truly adds value over a strategic approach, particularly in environments marked by high market uncertainty.
Which scientific methods are employed?
The author uses a qualitative literature review and evaluates quantitative findings from empirical studies conducted by researchers such as Darst, Brinson, and Dichtl.
What topics are covered in the main section?
The main sections cover the technical definitions of various shifting rules, portfolio insurance, comparative performance evaluations, and the analysis of risk factors under high uncertainty.
Which keywords best characterize this work?
The work is characterized by terms like SAA, TAA, correlation breakdown, forecasting accuracy, and efficient frontier.
How does the paper view the relationship between SAA and TAA?
The author suggests that instead of viewing them as competitors, they should be seen as a symbiosis where SAA provides the necessary framework and TAA attempts to generate additional value.
Why does the author consider forecasting so difficult?
The author highlights that successful forecasting requires a level of accuracy and hit rates that may be unattainable for most professional managers, often bordering on insider information.
What role does the "correlation breakdown" play in asset management?
It explains why correlations between assets increase during high market volatility, thereby reducing the intended benefits of diversification exactly when it is needed most.
- Quote paper
- BSc Daniel Hosp (Author), 2012, Strategic versus tactical asset allocation in markets with high uncertainty, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/209080
