Image Credit: Christophe Vorlet
By Jason Zweig | Nov. 2, 2012 11:48 p.m. ET
Buy-and-hold is beating dodge-and-weave.
After years of being mocked as “buy and hope,” the patient strategy of holding stocks and bonds is paying off again. By contrast, many “tactical” funds, which seek to smooth out short-term market swings through more-frequent trading, are coming up short.
The managers of tactical funds rightly say their period of underperformance is too short to predict future results.
Still, it is worth asking whether funds that take a short-term outlook are the best way to achieve long-term goals.
The classic “balanced” portfolio favored by prudent investors — 60% in stocks, 40% in bonds — is up 11.2% over the past 12 months and 10.4% annually for the past three years.
Over the past decade, this no-brainer portfolio earned 6.3% annually. Even over the past five years, as stocks barely got back to where they stood before the financial crisis, a buy-and-do-nothing investor gained an average of 2.8% a year — thanks to the strong returns on bonds.
Even so, investors have flung money at tactical funds. These portfolios don’t place bets on stocks, bonds or other assets and let them ride. They trade in and out, seeking to earn positive returns as markets go up and to limit losses when markets go down. If buy-and-hold investors are tortoises, tactical funds are hares.
Two-thirds of these funds didn’t even exist before the financial crisis erupted in 2008. The terror of watching their stocks lose 40% or more in 2008 and 2009 has driven investors to tactical funds in droves, industry experts say.
After 2008, people have come to the realization of how important it is to be able to scale risk down and not be stuck to a fixed allocation,” says Sridip Mukhopadhyaya, lead manager of the $760 million Transamerica Tactical Income Fund.
Morningstar, the research firm, tracks 42 mutual funds and exchange-traded funds with “tactical” in their name, up from eight in 2007. Of their $4.3 billion in assets, 20% poured in this year alone.
As usual, investors appear to have stampeded into a trend at an inopportune time. Mutual funds with “tactical” in their name are up 6.9% this year — an average of five percentage points less than the various indexes they follow, according to Morningstar. Over the past three years, these funds have gained an annual average of 4.9%, or more than six points a year behind their benchmarks.
With U.S. stocks doing so well, that isn’t surprising. In fact, say tactical managers, it is all but inevitable. These funds can’t predict the future. By bailing out of falling markets, they seek to do better when stocks or other assets do badly. Conversely, they are likely to lag behind in bull markets, because they rarely put all their money to work in one place.
“The last few years have been pretty daunting for our strategy,” says Ricardo Cortez of the $1 billion Forward Tactical Growth Fund. “Our model tries to follow the market, but the market’s kept going up” — so funds that aren’t all stocks, all the time, have been left behind.
When U.S. stocks are surging, says Mebane Faber, co-manager of the $70 million Cambria Global Tactical ETF, “we’ll look worse by comparison, because we have such a small weight there.” At last count, his fund had only about 12% in U.S. stocks, versus 24% in commodities and 21% in real estate, on the belief that U.S. stocks are relatively overvalued.
The managers argue that they can reduce risk by cutting exposure to investments that are no longer cheap. “We focus on trying to be in the right asset class at the right time,” says Jeffrey Mellas, manager of the $422 million Wells Fargo Advantage WealthBuilder Tactical Equity Portfolio.
Some of these funds are designed to be able to shift virtually all their holdings into cash; others can go only part way. The ability to raise cash also reduces risk, say tactical managers. Unlike stocks, cash doesn’t fluctuate in value (leaving inflation aside). But anyone — including you — can smooth the ups and downs of a stock portfolio by holding some cash alongside it.
Meanwhile, almost none of these funds are old enough to have been tested in both bull and bear markets. Some “hold” their positions for only weeks at a time. Their annual expenses average a steep 1.46%, according to Morningstar — or nearly 15 times the cost of the Vanguard Balanced Index Fund.
That tortoise portfolio, which plods along with a steady 60% of its assets in U.S. stocks and 40% in bonds, is up an annual average of 7.15% over the past 10 years. Over the past three years, it has earned 11% annually — more than twice the hares’ average return.
Mind you, the stock market could crash again tomorrow. And much of the good performance of the balanced tortoise strategy came from its 40% position in bonds.
As Mr. Faber points out, with bond yields near record lows, the buy-and-hold strategy isn’t going to benefit from that tailwind in the future — so its partisans should ratchet their expectations downward. A tortoise would be lucky to earn a 4% annual return over the next decade on a balanced portfolio.
How will the hares do? Who knows?
Source: The Wall Street Journal, https://www.wsj.com/articles/SB10001424052970204707104578095052760641218
Resources:
Definition of TACTICAL ASSET ALLOCATION in The Devil’s Financial Dictionary