Morningstar Advisor - October/November 2010 - 52

In Practice

Tactical Strategies Miss Their Mark
By Jeffrey Ptak

Only a handful of funds are able to provide solid returns in both up and down markets.

“How tactical are you?” As a registered investment advisor managing strategies for advisors and their clients, we’ve gotten this question a lot. Advisors want to know if we’ll blow out of our investments if the market goes to pot; their clients seek reassurance that we’re sufficiently “active.” Morningstar Investment Services does use tactical allocation, but in a pretty limited way—to slightly shade our target asset-class weightings based on our intermediate-term outlook. We’ve been skeptics of tactical strategies that make jarring moves between asset classes. In our experience, these strategies tend to have inconsistent success. But we had never systematically analyzed that assertion—most of our encounters with tactical strategies have been on a case-by-case basis. So, we tested our assumptions and evaluated the effectiveness of tactical funds, many of which have debuted recently.
Tactical 101

shape-shifting quality, reflecting changes in the manager’s near-term outlook. Time horizon can be a key differentiator of tactical strategies, which typically invest with the aim of delivering good results in varying market climates by shifting between asset classes. In fact, many tactical strategies take pains to avoid downturns, a tack that managers hope will lead to outperformance in a choppy, sideways market. Not surprisingly, the recent market volatility has generated heightened interest in tactical allocation. The industry has taken notice: We’ve seen fund companies launch a raft of tactical strategies recently. As of August, nearly 50 tactically oriented mutual funds had been launched in the past two years. Given their short track records and amorphous portfolios, tactical strategies can be tricky to screen. We used a few methods, including naming convention (funds that have words such as “tactical” or “defensive” in their names) and portfolio variance (such as volatility of “balanced” fund asset-class weightings) to identify them in Morningstar’s database. For this study, we excluded strategies such as income-and-growth and absolute return unless their mandates called for tactical allocation. Those screens left us with a group of 163 tactical mutual fund strategies, 39 of which no

longer exist (because of merger or liquidation). Of the surviving tactical strategies in our peer group, the median life span was 37 months as of July 31.
Upside and Downside

Tactical strategies typically seek to capture some meaningful portion of the market’s upside while avoiding sharp corrections. With that in mind, we began our study by measuring the extent to which these strategies participated in the S&P 500 Index’s gains and losses. We calculated since-inception upside and downside capture ratios for every tactical strategy, including those that were merged or liquidated, and compared them with the capture ratios of Vanguard Balanced Index VBINX. The Vanguard fund is a good benchmark: It passively invests in a static 60%/40% mix of stocks and bonds, meaning that it’s fully exposed to the elements in the markets. What we found is that many of these tactical strategies didn’t measure up to Vanguard Balanced Index. For example, of the 62 tactical strategies that were at least three years old as of July 31, only half had smaller downside capture ratios than the Vanguard fund’s. Of those, only 13 notched superior since-inception annualized returns to the Vanguard offering. The other 31 strategies either exhibited larger downside capture ratios than the Vanguard fund’s or the lethal combination of larger

Though definitions vary, tactical investing entails significant shifts between asset classes. There may not be a strategic asset allocation to moor the portfolio to a certain target mix of stocks, bonds, and alternative assets, or if there is, the tethers might be loose. For that reason, tactical portfolios can have a

52 Morningstar Advisor October/November 2010



Morningstar Advisor - October/November 2010

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2010

Morningstar Advisor - October/November 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What estate-planning strategies are you and your clients doing before the end of the year?
Next Steps for ETFs
Investment Briefs
Taking It Personal
A Model Practice
Find the Right Fit
Will REITs Put You in the Penthouse?
Prepare for the Worst
Tips for Common Family Situations
Might Makes Right
Built to Last
Four Picks for the Present
Tactical Strategies Miss Their Mark
Time to Hop on the Commodities Bandwagon?
Retailers Balance Caution and Catalysts
In Search of … Recession Survivors
Turmoil-Tested Small-Cap Funds
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Rise in Second Quarter
The Third Rail
Morningstar Advisor - October/November 2010 - Intro
Morningstar Advisor - October/November 2010 - Morningstar Advisor - October/November 2010
Morningstar Advisor - October/November 2010 - Cover2
Morningstar Advisor - October/November 2010 - 1
Morningstar Advisor - October/November 2010 - 2
Morningstar Advisor - October/November 2010 - Contents
Morningstar Advisor - October/November 2010 - 4
Morningstar Advisor - October/November 2010 - 5
Morningstar Advisor - October/November 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - October/November 2010 - 7
Morningstar Advisor - October/November 2010 - Contributors
Morningstar Advisor - October/November 2010 - Letter From the Editor
Morningstar Advisor - October/November 2010 - What estate-planning strategies are you and your clients doing before the end of the year?
Morningstar Advisor - October/November 2010 - 11
Morningstar Advisor - October/November 2010 - Next Steps for ETFs
Morningstar Advisor - October/November 2010 - 13
Morningstar Advisor - October/November 2010 - Investment Briefs
Morningstar Advisor - October/November 2010 - 15
Morningstar Advisor - October/November 2010 - 16
Morningstar Advisor - October/November 2010 - 17
Morningstar Advisor - October/November 2010 - Taking It Personal
Morningstar Advisor - October/November 2010 - 19
Morningstar Advisor - October/November 2010 - A Model Practice
Morningstar Advisor - October/November 2010 - 21
Morningstar Advisor - October/November 2010 - Find the Right Fit
Morningstar Advisor - October/November 2010 - 23
Morningstar Advisor - October/November 2010 - 24
Morningstar Advisor - October/November 2010 - 25
Morningstar Advisor - October/November 2010 - Will REITs Put You in the Penthouse?
Morningstar Advisor - October/November 2010 - 27
Morningstar Advisor - October/November 2010 - 28
Morningstar Advisor - October/November 2010 - 29
Morningstar Advisor - October/November 2010 - 30
Morningstar Advisor - October/November 2010 - 31
Morningstar Advisor - October/November 2010 - Prepare for the Worst
Morningstar Advisor - October/November 2010 - 33
Morningstar Advisor - October/November 2010 - 34
Morningstar Advisor - October/November 2010 - 35
Morningstar Advisor - October/November 2010 - Tips for Common Family Situations
Morningstar Advisor - October/November 2010 - 37
Morningstar Advisor - October/November 2010 - Might Makes Right
Morningstar Advisor - October/November 2010 - 39
Morningstar Advisor - October/November 2010 - 40
Morningstar Advisor - October/November 2010 - 41
Morningstar Advisor - October/November 2010 - 42
Morningstar Advisor - October/November 2010 - 43
Morningstar Advisor - October/November 2010 - 44
Morningstar Advisor - October/November 2010 - 45
Morningstar Advisor - October/November 2010 - Built to Last
Morningstar Advisor - October/November 2010 - 47
Morningstar Advisor - October/November 2010 - 48
Morningstar Advisor - October/November 2010 - 49
Morningstar Advisor - October/November 2010 - Four Picks for the Present
Morningstar Advisor - October/November 2010 - 51
Morningstar Advisor - October/November 2010 - Tactical Strategies Miss Their Mark
Morningstar Advisor - October/November 2010 - 53
Morningstar Advisor - October/November 2010 - 54
Morningstar Advisor - October/November 2010 - 55
Morningstar Advisor - October/November 2010 - 56
Morningstar Advisor - October/November 2010 - 57
Morningstar Advisor - October/November 2010 - Time to Hop on the Commodities Bandwagon?
Morningstar Advisor - October/November 2010 - 59
Morningstar Advisor - October/November 2010 - 60
Morningstar Advisor - October/November 2010 - Retailers Balance Caution and Catalysts
Morningstar Advisor - October/November 2010 - 62
Morningstar Advisor - October/November 2010 - 63
Morningstar Advisor - October/November 2010 - 64
Morningstar Advisor - October/November 2010 - 65
Morningstar Advisor - October/November 2010 - In Search of … Recession Survivors
Morningstar Advisor - October/November 2010 - 67
Morningstar Advisor - October/November 2010 - Turmoil-Tested Small-Cap Funds
Morningstar Advisor - October/November 2010 - 69
Morningstar Advisor - October/November 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - October/November 2010 - 71
Morningstar Advisor - October/November 2010 - 72
Morningstar Advisor - October/November 2010 - 73
Morningstar Advisor - October/November 2010 - 50 Most Popular ETFs
Morningstar Advisor - October/November 2010 - 75
Morningstar Advisor - October/November 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - October/November 2010 - 77
Morningstar Advisor - October/November 2010 - VA Sales Rise in Second Quarter
Morningstar Advisor - October/November 2010 - 79
Morningstar Advisor - October/November 2010 - The Third Rail
Morningstar Advisor - October/November 2010 - Cover3
Morningstar Advisor - October/November 2010 - Cover4
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