Have your cake

I get asked from time to time about being tactical with part of an investment portfolio, and I often see advisors touting such a strategy. Usually the pitch is that the advisor uses a strategic (meaning fixed) asset allocation for the “core” of the portfolio and then makes tactical moves between asset classes or in/out of the markets with a “sleeve.” This allows the advisor to admit with one side of his/her mouth that a strategic allocation makes the most sense as markets aren’t predictable, but right out of the other side promise to add value in some manner by making tactical moves with some of the portfolio.  Usually this value-add promise has something to do with reducing bear market risk (which is every investor’s holy grail). What really gets to me is finding such promises from advisors who otherwise preach (relatively) efficient markets and advocate for the use of index funds (but I’ve ranted about that in the past).

I’ll admit: I don’t get it. Either markets are unpredictable over practically any time period or they aren’t. Either you know what is coming next or you don’t. What is the point of saying you know what is coming next, but only for 10% of the portfolio? If you really knew, wouldn’t you be all over that? I would be! Now somebody is going to say it’s about “hedging your bets” and to that I say: bull.

What this is really about is the same performance promising behavior advisors have practiced for decades, but also managing your career risk as an advisor. If you’re tactical with 10%, you get to sell the illusion that activity breeds outperformance without the risk of losing a client when you are inevitably wrong. When the market is in free fall and your client calls nervous and asking what you are doing, you get to say that you are doing something instead of reminding the client that these things happen and declines are part of being a long-term investor and when our IPS calls for it we will rebalance. It’s much, much easier to say “well, we just hit our sell trigger for the tactical sleeve so we moved that money out of the market.” The (naive) client is instantly relieved that you are “cutting their losses” and pats themselves on the back for having such a sophisticated strategy.

The thing that’s going on here is the psychological relief of doing something. As I mentioned recently, doing nothing is really hard.  We just aren’t designed for it. So the tactical sleeve acts as a blow-off valve for pent up demand for activity. Which, if you are an investor who struggles with the discipline required to make a long-term investment strategy work, maybe it is worth the cost. But the tactical sleeve should come with a warning label like a pack of cigarettes:

WARNING: THE ACTIVITY YOU ARE ABOUT TO UNDERTAKE IS ALL BUT GUARANTEED TO INCREASE YOUR PORTFOLIO COSTS, INCREASE TAX DRAG AND REDUCE YOUR LONG-TERM RETURNS. YOU ARE EXTREMELY LIKELY TO DO A TERRIBLE JOB AT TIMING THIS TRADE AND YOU SHOULD RECONSIDER IF STAYING IN A LONG-TERM POSITION WILL BE BETTER FOR YOUR INVESTMENT RESULTS.