Systematic Tactical Asset Allocation Management
Superior returns through active investment management can be achieved in two ways: security selection, and/or active (or tactical) asset allocation (TAA). A good definition of TAA is given in the Reference for Business: “Tactical asset allocation is an investment strategy that centers on altering investment proportions to take advantage of differences in expected performance of various asset classes.”
“Active management is forecasting” - Grinold and Kahn, Active Portfolio Management (1999). The authors establish the following relationship between active return (alpha) and forecasting skill, or information coefficient (IC):
α = σ × IC × Score
The key to achieving superior active return, therefore, is the forecasting skill, IC. In the case of TAA, it requires forecasting of returns with a good degree of confidence, for broad asset classes (such as equities and fixed income). At Performance Analytics, we forecast equity index returns using our advanced PAR Model™. We provide research to investment managers, which includes the expected index returns, as well as our asset allocation recommendations and commentary.
Balanced portfolio managers including pension funds, endowments, sovereign wealth funds, and family offices can improve their risk/return performance using a tactical asset allocation strategy, based on the results of our asset allocation research. These results can also help absolute return managers and hedge funds better manage their net equity exposure, long-short ratio, or leverage.
The PAR Model™
Quoting Grinold and Kahn (1999) once again: “A good forecaster has IC = 0.05, a great forecaster has IC = 0.10, and a world-class forecaster has IC = 0.15.” The IC obtained using our model is 0.78 in back-testing over five-years, and 0.76 over 10 years ending in December, 2011 – clearly raising the bar for “world-class” forecasting!
We achieved this forecasting ability by means of the multi-factor dynamic regression model (the PAR Model™) that we developed at Performance Analytics. Having better equity return forecasts enables our investment management clients to make better-informed decisions, and to achieve alpha via active asset allocation.