Strategic asset allocation has been the most prominent form of asset allocation for decades now. It is a lovely theory and makes for a slick presentation for a client. But, there’s a problem with it. A very big problem. Strategic asset allocation models rely on historical inputs (returns, correlations, and variances) of different asset classes to generate an allocation that “maximizes the return for a given level of risk.” Relying on historical statistical relationships, a strategic asset allocation model can propose just how much of a portfolio should be allocated to US equities, international equities, currencies, commodities, real estate, and fixed income. The most common method for generating the required inputs for a strategic asset allocation model is to use a long-term data set, say 50 or 75 years. This will give you a stationary data point for each of the inputs. Strategic asset allocation will work just fine, as long as the future consistently looks just like each of those stationary inputs. This might happen. It never has in the past, but it might…
The chart below might just be the single best way to explain the benefits of tactical asset allocation over strategic asset allocation.
(Click to Enlarge)
Source: Arrow Funds
These efficient frontiers of bonds and equities have been all over the map! Each decade was a little, or a lot, different. You can use 75 years worth of data to tell you about the average statistical relationship, but this may do you little good over the next 10 or 20 years. Financial professionals can click here, and then click on Global Macro Presentation to see an alternative approach to asset allocation.
Click here to visit ArrowFunds.com for a prospectus & disclosures. Click here for disclosures from Dorsey Wright Money Management. Past performance is no guarantee of future results.
Posted by Andy Hyer 
