10.4.6.2. Actively Managed Strategies: Tactical Asset Allocation
Unlike a strategic asset allocation model that relies on keeping an optimum portfolio mix to maximize return, the tactical asset allocation model attempts to time the market, moving in and out of asset classes and sectors based on certain indicators of the direction of the market. Because it relies on market timing, tactical asset allocation is considered an active strategy. Strategic asset allocation is considered a passive strategy because it sticks to a chosen allocation, regardless of the performance of the market.
Active portfolio management styles are designed to outperform the market. Theoretically, actively managed portfolios can limit a portfolio’s risk by the manager moving out of a position, sector, or market prior to an anticipated drop.
However, an active management style comes with a number of distinct downsides. Most importantly, it carries the potential for dramatic underperformance of the market, including substantial losses compared to the broad market. Active management can also lead to increased short-term capital gains taxes on positions held for only a short time and substantial trading costs that can either eat away at an investor’s profits or deepen their losses.
Sample Question 1
Which of the following is a passive investment strategy?
A. Risk arbitrage techniques
B. Short selling to profit from expected movements in stock prices
C. Purchasing options to increase leverage or take advantage of expected movements in stock prices
D. Dollar cost averaging
Answer: D. Timing the market, risk arbitrage techniques, purchasing securities on margin to increase leverage, short selling to profit from expected movements in stock prices, and purchasing options to increase leverage or take advantage of expected movements in stock prices are all active investment strategies. Purchasing ETFs and index funds, dollar cost averaging, laddering, and some