R26 - Tactical Asset Allocation

CFAI text, V3, P316~320 I don’t understand the three principles well. What are the focal points of those statements regarding Exhibit 49/50 ? Anyone can explain ?

I don’t either. I understand principle 3, mean reverting, but not the other two. I don’t know what these principles mean in tactical asset allocation. Any help would be greatly appreciated… Thanks.

  1. Market prices tell explicitly what returns are available. Example given by Stalla is that “a stock’s return can be estimated by using the dividend yield plus the growth rate.” (DDM) I guess what its saying is that since stock prices are public knowledge, you can determine the expected return (future prices - current prices) for the stocks based on various models. Whatever data is available shows what returns are available. 2. Relative expected returns reflect relative risk perceptions. This is the basic relationship between risk and return. Investors want additional return for assuming additional risk. If the perceived relative risk is high (i.e. Emerging markets equity), then they expect higher returns. 3. Markets are rational and mean reverting.

Thanks programmer. Now I have to ask one silly question. How are these principles relevant to TAA?? I may be hung up with something that’s not important at all but I still have hard time to make a connection for them… I think I understand the connection vaguely and I am hoping someone can explain it in a little more plain language… Thanks!

1 and 3 are simple: Short term mispricing can be exploited by making short term bets .If you think stock is overpriced according to DDM or another ratio that is mean-reverting longer term , borrow and short the stock. Buy and hold the stock if you think it is underpriced and the market hasn’t realized it yet, but will soon. These are tactical moves , not related to a longer term fundamental analysis ( by sector strength or other macro expectation)