Tactical asset allocation: the flexibility advantage

STRATEGIC asset allocation (SAA) determines long-run exposure to systematic risk factors. That said, current changes in monetary policy in many developed and emerging countries as well as the stage of the business cycle warrant tactical considerations.

The tactical overlay strategy should generate added value by temporarily deviating from the weights assigned in the SAA process. Let me explain.

Asset allocation dictates the expected risk and return as well as the portfolio's cash flow pattern. Empirical analysis demonstrates that asset allocation is the key driver of variation in returns over time. In "Determinants of Portfolio Performance", for example, Gary Brinson, CFA, L Randolph Hood, CFA, and Gilbert Beebower conclude that asset allocation explains on average about 90 per cent of the variation, while timing and security selection account for the rest.