Morningstar Advisor - October/November 2010 - 53

downside-capture ratios and smaller upsidecapture ratios. Flex-funds Defensive Balanced FLDFX, for example, captured about 65% of the S&P’s losses from its April 2006 inception (versus 58% for Vanguard Balanced Index) and 65% of the S&P 500’s gains (versus 70% for the Vanguard fund). Nine of these 31 strategies posted better since-inception annualized returns than the Vanguard fund. We also examined the performance of 30 tactical strategies that were one to three years old as of July 31. While 17 of these strategies held the downside better than the Vanguard fund, only five realized better since-inception returns. Why? Many of these strategies, such as Virtus Tactical Allocation NAINX, launched in 2009, just as a huge rally was stirring. This made upside capture far more important in the ensuing months. Unfortunately, the managers of these strategies had positioned their charges conservatively and didn’t adjust fast enough, missing out on some of the gains. We found that 64 of the 92 tactical strategies that were at least a year old as of July 31 posted worse since-inception returns than the Vanguard fund over the corresponding period. The average underperformance was 2.61% annualized. The results improved slightly on a risk-adjusted basis. When we calculated each strategy’s since-inception Sortino ratio (a variant of the Sharpe ratio that puts more emphasis on downside deviation), 30 of the 92 strategies bested the Vanguard fund. So, a few of the strategies whose since-inception returns had lagged the Vanguard fund’s, such as Manning & Napier Pro-Blend Conservative Term EXDAX, fared a bit better once downside was factored in.
Tactical Equals Insurance?

Balanced Index. To do so, we compiled statistics on the “maximum drawdown” of each strategy since inception and compared them with that of Vanguard Balanced Index. The results were striking: Of the 62 tactical funds with at least a three-year track record as of July 31, 42 suffered maximum drawdowns that were comparable to or worse than the maximum drawdown of the Vanguard fund over the same period. For example, from its April 2006 inception through July 31, the AdvisorOne Liahona Fund CLHAX experienced a maximum drawdown of negative 43.4% versus negative 32.6% for the Vanguard fund over the same span.
The Boneyard

GMWAX and PIMCO All Asset PASDX, that

bucked the odds in posting solid risk-adjusted returns over an extended period. What set these strategies apart? They tended to stress long-term fundamentals. GMO’s assetallocation research, for example, is predicated to a large extent on mean-reversion. The firm pays attention to metrics such as normalized valuations, yields, and profit margins and forecasts over a long time horizon (seven years). Though GMO’s analysis of investor behavior colors its asset-allocation research (the tendency of markets to overshoot to the upside and downside), its valuation and other metrics are based on historical market averages. In other words, the firm is not trying to be a hero every month, quarter, and year. What didn’t work? We found scant evidence that rapid-fire trading enhanced results— portfolio turnover averaged more than 200% among the tactical funds we analyzed, most of which didn’t distinguish themselves. High fees didn’t help, either: The typical tactical fund’s expense ratio was 1.65%—almost 7 times that of Vanguard Balanced Index. These results reinforce our belief that tactical allocation is no panacea: A long-term, fundamentals-based approach is important to success. Our current approach, adjusting asset allocation based on assessments of intermediate- and long-term fundamentals, including valuations, isn’t changing. K
Jeffrey Ptak, CFA, CPA, is president and chief investment officer of Morningstar Investment Services. About Morningstar Investment Services Morningstar Investment Services brings fee-based advisors the resources of an independent, experienced investment team. Its range of customizable stock, ETF, and mutual fund portfolios is guided by proprietary methodologies and leverages Morningstar’s research. For more information, visit http://global.morningstar. com/mis or call 877-751-4208.

These findings don’t reflect the results of the many tactical funds that have been merged or liquidated away. Nearly 30 tactically oriented strategies have been shuttered since 2006, and these funds were poor performers. For example, from its August 2005 inception through its September 2007 liquidation, the Integrity All-Seasons Fund’s annualized returns lagged Vanguard Balanced Index’s by around 6 percentage points and were no less volatile. And then there are the “living dead”—tactical funds that are really reincarnated versions of formerly unsuccessful strategies. The Stadion Managed Portfolio ETFFX and Stadion Core Advantage Portfolio ETFRX funds, for example, boast solid since-inception risk-adjusted returns. However, these funds are simply newer share classes of strategies that didn’t prove potent until the 2008–09 bloodbath. (The old share classes, which bore the results of the strategies’ previous futility, were eliminated after being merged into the new share classes in 2006.) In other words, these funds’ reported results present an incomplete picture of the underlying strategies’ effectiveness.
What Worked?

Of course, some investors have embraced tactical strategies not as all-weather vehicles, but as insurance against big declines. Accordingly, we also examined whether the tactical strategies in our peer group better withstood big market dips than Vanguard

If there was a silver lining here, it was in identifying a handful of tactical strategies, such as GMO Global Balanced Asset Allocation III

MorningstarAdvisor.com 53


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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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