Morningstar conference update: Tactical approach can boost returns, says fund manager

(May 7, 2004) Although he’s a staunch advocate of asset allocation, fund manager David Picton believes it is possible to add returns to portfolios by shifting the asset mix.

Picton made his case for tactical asset allocation at Morningstar Canada’s “Lessons in Effective Portfolio Construction” conference in Toronto earlier this week.

Picton is senior vice-president, portfolio management with CI Mutual Funds and lead manager of the Synergy Tactical Asset Allocation Fund, which has a five-year history of beating its group average and peer group index.

It’s accepted wisdom that well-diversified portfolios give better risk-adjusted returns than any single asset class alone. But early on in his talk the portfolio manager squelched the common misconception that asset allocation accounts for over 90% of a portfolio’s return.

That famous Brinson-Hood-Beebower study, the subject of recent media debate, actually said asset allocation explained 93.6% of the variation in total plan returns. “The market,” noted Picton, “seems to have interpreted this to mean that investors should just set a long-term asset mix, then sit back and relax.”

Not so, said Picton. “Explaining variability is not the same as explaining returns or return differences across investments,” he pointed out. “Even if strategic asset allocation explains 90% of a portfolio’s variability, there’s still plenty of opportunity to enhance return through tactical asset allocation and security selection.”

Picton is a well-known momentum manager but he said Synergy’s tactical asset allocation process uses a number of other considerations including valuations, credit spreads, the shape of the yield curve, economic growth indicators and even investor sentiment. He also takes into account equity styles which can figure dramatically in some years.

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Tactical asset allocation does, however, add more risk to a portfolio because the manager has to get more asset shift calls right than wrong. But Picton believes a good tactical asset allocation may boost risk-adjusted returns compared to a static (a.k.a. strategic) allocation. He cautions advisors and investors to scrutinize the process involved in determining the asset repositionings.

Picton said the method has to make economic sense, be disciplined and show acceptable risk controls. Most important, he believes the process must work and be repeatable.

So, if you agree that the markets are not perfectly efficient, tactical asset allocation may help you capture the shifts in equity style returns and sector strengths. With equity returns expected to stay unspectacular for some time, Picton thinks the added value of a tactical approach could help your clients balance their aversion to risk with their need for a long and robust retirement income stream.

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Donna Green, MA, CFP, is a personal finance writer and assistant author of The New Investment Frontier: A Guide to Exchange Traded Funds for Canadians, and Surprise! You’re Wealthy: A Woman’s Guide to Protecting Her Wealth.

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(05/07/04)