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Tactical Asset Allocation (TAA)

An active management portfolio strategy that shifts asset allocations in a portfolio to take advantage of market trends or economic conditions

What is Tactical Asset Allocation (TAA)?

Tactical asset allocation (TAA) refers to an active management portfolio strategy that shifts asset allocations in a portfolio to take advantage of market trends or economic conditions. In other words, tactical asset allocation refers to an investment style in which asset classes such as stocks, bonds, cash, etc. are adjusted in the portfolio to account for macroeconomic events.

 

Tactical Asset Allocation

 

Quick Summary:

  • Tactical asset allocation refers to an active management portfolio strategy that shifts the asset allocations in a portfolio to take advantage of macroeconomic conditions.
  • The tactical asset allocation strategy can be used to increase returns, adapt to market conditions, and provide diversification.
  • Tactical asset allocation can be used within an asset class.

 

Understanding Tactical Asset Allocation

The underlying premise behind tactical asset allocation is to first focus on asset allocation and securities selection second. Those who invest using a tactical asset allocation looks at the “bigger picture” and believes that the allocation of assets exerts a greater impact on portfolio returns than individually selecting securities.

For example, consider the data below regarding the S&P 500 return (“stock return”) and Barclays U.S. Aggregate Bond Index (“bond return”) return provided by The Balance. Note that cash does not generate a return:

 

Tactical Asset Allocation

 

As one can see, stock returns outpaced bond returns from 1997 to 1999. From 2000 to 2001, bond returns outpaced stock returns. A tactical asset allocation strategy might show the following asset class allocation over the years:

 

Sample Data

 

Compared to an investor that might have solely invested in stocks from 1997 to 2001, tactical asset allocation would have mitigated the poor performance of stocks in 2000 and 2001 by shifting the asset allocation to bonds.

In essence, the goal of tactical asset allocation is to adjust the asset class in a portfolio to asset classes that are expected to perform better relative to other asset classes.

 

Reasons for Tactical Asset Allocation

Tactical asset allocations serve many functions, including:

 

1. Increasing returns

Using tactical asset allocation to shift asset allocations to stronger performers increases the portfolio return. Doing so allows the portfolio to capture the upside in an asset class while moving away from poorly performing asset classes.

 

2. Adapting to market conditions

Tactical asset allocation is flexible and responds to macroeconomic events. As seen with the stock market in 2000 and 2008, stocks significantly underperformed several other asset classes. A tactical asset allocation strategy shifts the asset allocation accordingly to account for macroeconomic conditions.

 

3. Providing diversification

Investing solely in one asset class increases the risk of the portfolio. By diversifying through tactical asset allocation, greater returns can potentially be realized with lower risks.

 

Example of Tactical Asset Allocation

In his investment policy statement, John indicated that he wants an asset allocation consisting of 45% stocks / 45% bonds / 10% cash. Historically, stocks have performed extremely well.

The portfolio manager of John recently noted that the yield curve has inverted, a leading indicator of a recession. The portfolio manager tells John that the portfolio’s asset class should be shifted to 20% stocks / 70% bonds / 10% cash due to fears of a recession and potentially poor stock returns. In doing so, the portfolio manager is employing a tactical asset allocation strategy.

 

Tactical Asset Allocation Within an Asset Class

We saw that tactical asset allocation was used to shift asset classes within a portfolio. For example, in the example above, A tactical asset allocation strategy was used to shift the asset classes of John’s portfolio below:

From:

  • 45% stock
  • 45% bond
  • 10% cash

 

To:

  • 20% stock
  • 70% bond
  • 10% cash

 

Tactical asset allocation can also be used within an asset class. For example, consider the asset class allocation of 20% stocks / 70% bonds / 10% cash. We can use tactical asset allocation within an asset class as follows:

Within 20% stock allocation:

  • 20% large-cap domestic stocks
  • 50% medium-cap domestic stocks
  • 15% small-cap domestic stocks
  • 5% micro-cap domestic stocks
  • 10% foreign stocks

 

Within 70% bond allocation:

  • 30% treasury bonds
  • 50% investment-grade bonds
  • 20% non-investment grade bonds

 

Within 10% cash allocation:

  • 100% cash

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Active Bond Portfolio Management
  • Diversification
  • Portfolio Manager
  • Investing: A Beginner’s Guide

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