May 14, 2012
Being tactical and market timing are not the same thing. Let's review.
Market timing in its pure sense means choosing a beta where the beta of the market equals 1 and the beta of cash equals 0. Asset allocation generally refers to a mix of 5-20 different types of investments.
A portfolio manager who is engaged in choosing country funds and makes a sale is not market timing, they are allocating assets. To the extent that their return and/or risk expectations change about a country, they of course may alter the portfolios holdings. Since they are making decisions on many different investments, it is not just based on changing between a beta and cash --- they are choosing and mixing many betas -- this is allocation.
Now let's review active vs passive. The most purely passive investor would have some type of a global allocation and would not change the portfolio weights based on expectations because a passive strategy does not have tactical expectations. It is having the ability to change your expectations of future returns that defines someone as active. A passive investor simply doesn't change their expectations about the capital markets -- or at least if they do and don't do anything about it when they change --- they are acting passively.
(Note that technically you can be passive and change the allocation, it would just have to be for some reasons other than capital markets expectations. An example here would be that some type of financial event happens in your life and you now need to take less risk as you will have some extra liquidity need sometime soon. The allocation could change to reflect this -- its just not due to investment related expectations).
Some people get confused and think that changing an allocation automatically means you are timing the market. No, if you fall into the 'active' category and your expectations change about a particular segment of the market, then it is frankly inconsistent with basic logic to NOT change your allocation. You change when your expectations for returns between assets change.
We think ETFs are interesting for their ability to alter portfolios efficiently, transparently and at ultra low-cost. Whatever your investment process is -- try to remain open on how to improve it. We think emphasizing portfolio management implementation techniques is what really matters most --- that is, allocation decisions. You can augment this core idea with either stock-selection or some component of passive buy & hold allocation ideas. There are no hard & fast rules on portfolio management other than this: favor reward/risk over just reward.
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