This is an embarrassingly basic question but I have to clear it. I had the impression that strategic asset allocation is a must for portfolio construction. Using Tactical Asset Allocation is more or less a choice. And using tactical asset allocation does not mean that the investor does not have or needc strategic asset allocation. It is used whenever there is a market opportunity because of shor term market expactations. When there is not, you shift back to strategic asset allocation. The question below is from Schweser. I found it confusing because the question positions Strategic & Tactical Asset Allocations as if they are exclusive options. Question 23612: Bruce Calloway is interested in utilizing an appropriate asset allocation strategy for his portfolio. His long-term view of the capital market conditions is that there will always be change and opportunities to capture excess returns in the market. As a risk neutral investor, he is a consistent risk taker and his risk tolerance on his portfolio can be expected to be constant based on such market expectations. Which asset allocation strategy is the most appropriate strategy for his portfolio? A) The mean variance approach asset allocation strategy best reflects Calloway’s view of market conditions since as market conditions change this strategy allows the asset allocation mix to change appropriately. B) The strategic asset allocation strategy is most appropriate since this strategy allows the portfolio to be periodically rebalanced according to market conditions. C) The tactical asset allocation strategy is most appropriate since this strategy assumes the investor’s risk tolerance is constant and his capital market expectations are subject to frequent change. D) The dynamic strategic asset allocation strategy is most appropriate since this allows the capability to quickly move in and out of different assets as market conditions change. Your answer: C was correct! Bruce Calloway is interested in utilizing an appropriate asset allocation strategy for his portfolio. His long-term view of the capital market conditions is that there will always be change and opportunities to capture excess returns in the market. As a risk neutral investor, he is a consistent risk taker and his risk tolerance on his portfolio can be expected to be constant based on such market expectations. Which asset allocation strategy is the most appropriate strategy for his portfolio? A) The mean variance approach asset allocation strategy best reflects Calloway’s view of market conditions since as market conditions change this strategy allows the asset allocation mix to change appropriately. B) The strategic asset allocation strategy is most appropriate since this strategy allows the portfolio to be periodically rebalanced according to market conditions. C) The tactical asset allocation strategy is most appropriate since this strategy assumes the investor’s risk tolerance is constant and his capital market expectations are subject to frequent change. D) The dynamic strategic asset allocation strategy is most appropriate since this allows the capability to quickly move in and out of different assets as market conditions change. Your answer: C was correct! Bruce Calloway is interested in utilizing an appropriate asset allocation strategy for his portfolio. His long-term view of the capital market conditions is that there will always be change and opportunities to capture excess returns in the market. As a risk neutral investor, he is a consistent risk taker and his risk tolerance on his portfolio can be expected to be constant based on such market expectations. Which asset allocation strategy is the most appropriate strategy for his portfolio? A) The mean variance approach asset allocation strategy best reflects Calloway’s view of market conditions since as market conditions change this strategy allows the asset allocation mix to change appropriately. B) The strategic asset allocation strategy is most appropriate since this strategy allows the portfolio to be periodically rebalanced according to market conditions. C) The tactical asset allocation strategy is most appropriate since this strategy assumes the investor’s risk tolerance is constant and his capital market expectations are subject to frequent change. D) The dynamic strategic asset allocation strategy is most appropriate since this allows the capability to quickly move in and out of different assets as market conditions change. Your answer: C was correct! The most appropriate asset allocation strategy is the tactical strategy. This strategy assumes that the investor’s risk tolerance is constant and his capital market expectations are subject to frequent change. The tactical strategy assumes that investment allocation decisions are based on current market conditions, but the risk tolerances do not change with changes in wealth levels. For example, when the market conditions are bearish, the investor’s view of risk does not change with respect to capital commitments to stocks and will allocate a consistent level of his portfolio to cash or bonds. In bull market or when markets rally, the investor’s risk tolerance will not change and would continue to allocate consistent amounts to stocks and cash or bonds.
I would say the question is conceptually incorrect. The strategic asset allocation is a basis for all types of investors. Yes, in some periods of time we could either choose to stick to strategic asset allocation or temporarily switch to tactic asset allocation to earn higher returns. But it’s not right to say that because we have constantly changing market conditions tactical asset allocation is most appropriate.
You are right. TAA is an optional overlay over SAA - essentially an active investment strategy at the asset class level. I think this is another bad question. Having said that it seems that the investor is aiming to capture excess returns by capitalizing on short-term market movements. This basically rules out A, B and D. More specifically, A - seems incorrect as MVO concerns itself with long term expectations and not frequent market gyrations (which seems to be the case here). Also, MVO by itself does not give excess returns (that’s the next step of how to implement SAA). B - Again SAA by itself does not give excess returns. D - SAA and quickly moving in and out are incompatible. So by elimination C does see to be correct. Plus it is consistent with frequent changes in CME. However, I really don’t understand the link between TAA and investor’s risk tolerance. I did this reading few days ago and there was no mention of risk tolerance as it relates to TAA.
My interpretation of this is that strategic asset allocation forms the base of the portfolio and is essentially a buy and hold concept in the sense that say you construct a portfolio of 60% equity, 40% bonds then you rebalance to those allocations when need be (based on preselected rebalancing criteria). Essentially, i interpret a strategic asset allocation only strategy as one that assumes markets are efficient. A subset of allocation strategy then is tacticle and that assumes inefficient markets as you will alter the weights of the portfolio based on current market conditions.
There are TAA dedicated funds out there, so you can invest in a Global TAA fund if you wanted to. I would have leaned towards the SAA just for the fact that CFAI has been stressing the importance of the SAA over and over again and that TAA is a ST strategy yada yada yada…althought C is most likely correct, I think it will just confuse people even more.
Thank you all! I would go with CFA interpretation, any ways.