Tactical Asset Allocation to Ride Volatility

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Investment Emotion rollercoaster

The current state of market and the crazy intraday volatility would have given lot of people sleepless night. People who were firm believer in a equity portfolio sold their stocks at the worst possible level!!

Why did this happen? Did they not know stock are cheaper than they had bought and will go back up? Did they not know this is temporary?

They knew all the facts.

The answer is FEAR. It’s such a strong emotion it makes you take extreme decisions. Having 75% allocation to equity and hoping 12% CAGR in 10 years seem good on paper but losing 20% of your hard earned money in a week is an extremely stressful situation to say the least

I have always believed in having a diversified portfolio where you can use such times to your advantage using tactical allocation!

The primary benefit of using an asset allocation tactic is to reduce volatility in your portfolio, and reducing volatility can help reduce market risk.

Asset allocation refers to how your investment are diversified among asset classes—not among individual stocks or industries, but among broad asset-class categories such as cash, stocks, bonds, alternatives and international funds.

Historically, broad asset classes have moved in relation to each other fairly consistently (i.e., when stocks are up, bonds tend to be down). The goal is to create a portfolio with a mix of classes that do not move in the same direction when the market changes. In doing so, you help keep risk and volatility in check.

TAA(tactical asset allocation) is about dynamic portfolio management, and requires that you pay attention to what is happening so that you can change your asset allocation to take advantage of current conditions. For example, if stocks are dropping, and offering a good bargain, it might be worth it to shift to more stocks in order to buy when valuations are low. That way, you get more bang for your buck. Later, as valuations increase, you can shift your asset allocation, selling for profits since you bought while prices were low.

The idea is to switch your asset allocation when conditions indicate that one asset might soon outperform another. Rather than focusing on picking particular investments, the idea is to focus on an entire asset class or sector at one time.

Why Tactical Allocation work?

Lot of people believe in efficient market hypothesis,according to which you can not predict prices of asset as all information is already priced .There are some limitation of this theory.

First everybody is not rational and fear and greed can impact everybody in different way.eg . Market moving 10% in a day!

The EMH (efficient market hypothesis) assumes everyone is seeking the highest risk adjusted returns. In my experience there are a shockingly high number of market participants whose incentives are not aligned with this goal:

Lot of Institutional Players do not care much about losses like individuals.Read “profit are privatized,losses are public” means they afford to take more risk as tax payer can save them, eg LIC

Lot of Traders have gambling mindset and tend to take riskier decision than a long term investor due to bonuses aligned to near term profit

Lot of Funds don’t want to stand out from peers by doing anything out of the box hence have a herd mentality (large cap mutualfunds)

Also efficient market hypothesis assumes every market participant is acting to produce the best risk adjusted return. In reality there are many different risk and return objectives. A 60 year old investor saving for retirement will have vastly different needs and risk tolerances than an endowment with an infinite time horizon. Every investor comes to the table with a different reason why they push the ‘buy’ and ‘sell’ buttons. Given this reality the market price cannot be considered ‘efficient’, it is merely the average of the thousands of conflicting needs of its underlying investors .

So by creating a dynamic portfolio we can choose what’s best for our investment horizon and risk appetite and not just follow the herd!

Tactical Allocation in Practice:

Portfolio March 1,2020:

My approximate portfolio in March first week looked like this

I had around 35% exposure to Equity(India and Foreign). I had decent amount in alternative yielding 12-14% . Some money in Debt ,arbitrage for liquidity.

Now after Market Crash Round 1:

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Both Indian and Global Markets lost 20% in a week. Nobody had imagined this blackswan.

Instead of panicking I bought Nifty ETF and few blue chips(ITC,Kotak etc).

I also bought global ETF and added to my portfolio.

Portfolio after 12th March 2020

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I have reallocated 5% each in Indian and Global market from Debt and alternate investment as they were intact from this equity market rout.

What Happens in Future ?

Either market moves up in next few months or it dips further down.I will consider any dip as an opportunity to add more money. I will increase my total exposure to equity to 60%+ in that scenario.As my time horizon is 10+ years I dont mind waiting for recovery. The truth is you can’t never predict the exact bottom , but you can always gauge the risk /reward at the every level for a given time horizon

Once market are back in track I will start reallocating some of the profit to other asset classes

The advantage of this strategy is that you don’t have to experience collateral damage of your portfolio. Had it been a 70% equity portfolio at the onset then

  • More notional loss
  • No opportunity to buy more equity at lower cost.

People can implement these simple strategy to make most out of volatility.One important thing while reallocation is to ensure your liquidity is not compromised as you do not want to be in a position where you need to sell your assets at unfavorable market conditions to meet monetary requirement!


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