Asset allocation less risky than timing the market

Adriaan Pask, PSG Wealth CIO.

Investors have two basic choices to make. Do it yourself by timing the market or by predicting corrections, or leave it to a multi-manager with strategic and tactical asset allocation skills.

According to PSG Wealth CIO, Adriaan Pask, timing the market by buying and selling stocks to make a profit in a short time period is a risky business.

“You will only get by if you are very lucky and relying solely on luck is not an investment strategy.”

There is a meaningful difference between market timing and strategic and tactical asset allocation. Strategic asset allocation (SAA) is the targeted asset allocation composition of a fund, assuming all asset classes are fairly valued.

A manager may have determined that to reach a CPI plus 5% targeted return, holding 60% equity, 40% cash asset allocation at fair value would yield the desired result. If the asset classes are not trading at fair value, the manager may adopt a tactical asset allocation (TAA) strategy.

A TAA strategy is a prudent and considered over- or underweight position relative to the SAA strategy. Continuing with the 60% equity, 40% cash asset allocation example above, if the manager feels that equities may be overpriced, the manager may decide to hold 50% equity, 50% cash asset allocation portfolio.

“The big difference between market timing and a TAA strategy is prudence and proximity. An astute asset allocator recognises that although it is possible to value various asset classes, it is not possible to time markets.

“If the Fund manager is of the opinion that the equity portion may be overpriced, he may hold a 50% equity allocation instead of a 60% equity allocation, but he will never hold 0% equity or 100% cash. The latter is market timing.

“A TAA strategy requires a level of prudence, and recognises a potential error in judgement. It always retains proximity to the original SAA targeted weightings. This largely depends on prevailing market conditions and the fund manager’s predetermined TAA parameter limits,” according to Pask.

In situations where the manager believes that equities are severely undervalued, he/she may allocate 75% to equity; a 15% overweight position. On the other hand, if the manager feels that equities offer very little value, he/she may elect to hold only 45% in equity.

A true TAA strategy can be time-consuming and complicated for do-it-yourself investors. It requires knowledge and skill. That is why a multi-asset asset allocation fund is a simple choice for many investors.