In the aftermath of the financial crisis firestorm, which ravaged the portfolios of buy-and-hold investors, dozens of new offerings employing tactical strategies have shot up in the mutual fund forest.
Although lacking a clear definition, tactical strategies encompass a variety of investment approaches, giving managers flexibility to invest in a wide range of asset classes, sometimes with few constraints.
From 57 funds and $42 billion in assets as of March 2009, Morningstar Inc. now counts 126 open-end tactical funds with about $113 billion in assets. That tally doesn't include tactical ETF strategies run as separate accounts, which also have ballooned.
Performance hasn't matched the newfound popularity, however. With the risk-on/risk-off choppiness of the markets since the crisis, many trend-following tactical approaches generally haven't worked, according to observers.
A study by The Leuthold Group LLC found that basic momentum strategies flopped over the past two years, compared with the buy-and-hold approach. A simple trend-following model returned just 5.9% annualized over 2010 and 2011, Leuthold found, versus 8.3% for the S&P 500.
By contrast, from 1940 through 2009, the model gained 12.5%, besting the S&P 500's 11%, while taking less risk.
“The risk-on, risk-off world has been very difficult,” said Eric Weigel, director of research at Leuthold. “Over the last two or three years, a lot of [tactical] strategies that have had good historical performance have stopped working [and] become more volatile.”
Trendless markets “have been the real challenge for these [tactical] managers,” said Michael Herbst, associate director of fund analysis at Morningstar.
LITTLE DIVERSIFICATION
A study released last month by Morningstar found that just 44 of the 81 tactical funds in existence since October 2007 captured less downside through December than the plain-vanilla Vanguard Balanced Index fund (VBINX), which uses a passive 60%/40% mix of stocks and bonds.
What's more, just six of the 44 funds captured as much upside as the Vanguard fund, wrote Jeff Ptak, chief investment officer at Morningstar Investment Services Inc. and author of the study, who added that over the 10-year period through December, “the average tactical fund would have delivered little incremental diversification” to the balanced fund.
Yet financial advisers have clearly become enamored of tactical approaches because they like the idea of avoiding some of the downside, said Barry Mendelson, managing partner at Capital Market Consultants LLC, which develops asset management platforms for advisers and broker-dealers.
“But they may not understand that [a tactical strategy] will lag on the upside,” he said. “There continues to be an ongoing need for expectation management” on the part of advisers, Mr. Mendelson said.
Financial professionals do appear to be choosy about the tactical managers that they use, and just a handful of tactical funds have attracted significant assets, Mr. Herbst said.
Two funds, Pimco's All Asset All Authority Fund (PAUIX) and the All Asset Fund (PAAIX), together with the Ivy Asset Strategy Fund (WASCX), have gathered the most.
The funds have performed relatively well and have longer records and managers who have been in place for a while, Mr. Herbst said.
Long track records are unusual. Few active managers, including those running ETF portfolios, have been around very long, analysts said.
“If you look at the universe of tactical ETF managers, it's embarrassing. We found about 150 firms,” Mr. Mendelson said.
A VARIED BUNCH
“Some have very little money; some are seasoned,” he said. “But there's a wide disparity.”
Investment policies can be broad, so advisers may have difficulty understanding how managers invest, Mr. Mendelson said.
Tactical managers can change rapidly, moving from 0% to 100% in stocks or bonds, Mr. Herbst said.
Managers with a goal of outpacing inflation over a market cycle tend to have a more moderate mix than managers trying to maximize returns.
Some money managers also use derivatives, which makes allocations that much more difficult to judge, Mr. Herbst said.
Tactical products “by their nature are more complex than products of a decade ago,” said Thomas Butch, chief executive of Ivy Funds Distributor Inc. “It's important that your due diligence acknowledges that.”
One final warning: Those who expect a tactical manager to have a crystal ball will be disappointed and could get hurt if they try to second-guess their guru, Mr. Herbst said.
“The big risk in using these [strategies] is staring back at you in the mirror,” he said.
“For tactical to work, you have to be doing what is uncomfortable,” said Robert Arnott, chairman of Research Affiliates LLC, subadviser to the Pimco All Asset products.
For example, he added to risk assets in September as the markets were tanking.
“I thought this [correction] was neat; some markets I hadn't liked moved into bargain territory,” Mr. Arnott said.
“But some clients called, saying, "You're my safe haven. What are you doing?'” Mr. Arnott said.
“What we were doing was being tactical.”
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