Evidence Investing

 
Rotate What? 03/18/2010
 
What is ‘Rotation’?  Well, it’s the methodical or systematic redeployment of portfolio capital into different asset classes over time based on some underlying (proven) theory.  The goal is to decrease volatility and increase Sharpe Ratio and total return.

My specifically, in the context of this blog, I am referring to asset rotation, sector rotation, or tactical asset allocation (TAA). 

Investopedia gives a fairly clean rudimentary definition (slightly modified): the TAA strategy allows portfolio managers to create extra value (ostensibly ‘beat the market’) by taking advantage of dynamic situations in the marketplace through active management of which asset classes the portfolio capital is deployed at any given time.  In other words,  you periodically and actively adjust the mix of assets as markets rise and fall and the economy strengthens and weakens. 

 TAA models exist to help investors identify and participate in outperforming sectors of all markets (usually via the stock market).  This is critical!  The way I like to think of it is that in any given economic climate or situation, there is at least one asset some where that is making money and increasing in value.

 Think of the two recent bear markets, generally from 2000 through 2002, and 2007 until March of 2009. During both of these periods, equities (the S&P) declined more than 50%, yet bonds were profitably during this time.  Gold has been profitably during many recessions as well...as well as a host of other sectors or asset classes.  The bottom line is that there is always money to be made somewhere, no matter what is happening to the economy or business cycle.    

 The key is finding which assets to actually be in at any given time…  Easier said than done, right?  Absolutely.  While TAA’s premise is not all that earth shattering (be in assets that make money), certain aspects of it are fairly revolutionary to many investors.  First, it is a radical departure from the buy-and-hold dogma often touted by the investment community for so-called ‘individual and unsophisticated investors.’  Secondly, TAA will steer investors into what may be the uncharted waters of alternative investments, such as commodities, real estate, etc.  Thirdly, by way of regular portfolio adjusting, we can see that trading costs (friction) can be an issue. 

So at this point there are two elephants in the room:

  1. Where’s the evidence to prove that TAA is better than buy and hold
  2. How do you determine when and where to switch asset classes
 No doubt these are the critical issues…but have faith, we will get to the answers of both of these questions very shortly.  Stay tuned.
 


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