September 21, 2023

Adding Value Through Tactical Asset Allocation

This is the fourth in a series on endowment management investing basics. You can find the other posts on the three pillars of ECF’s endowment strategy here, the basic principles of endowment fund structure, here, and on strategic asset allocation here.

Endowment funds are long-term funds, and they are appropriately invested in diversified portfolios of varying asset classes based on expectations about how each asset class will perform over the long term – typically, 10 years or more. Asset classes in an endowment portfolio will likely include equities and fixed income, US and international, large caps and small caps, and so on.

Yet in the short term, economic conditions and market forecasts may change. Think of recent events such as Covid and the Ukraine war, as well as stimulus funding, inflation, and interest rate hikes. The upshot – short-term asset class expectations may vary from long-term expectations. In response, some investment managers adjust endowment portfolios over the short term – effectively making tactical decisions – while staying grounded in overarching long-term – or strategic – decisions. This process is intended to add to the return of the portfolio.

What is Tactical Asset Allocation? Tactical asset allocation (TAA) is an active investment strategy that involves making short-term changes to a portfolio's asset allocation in response to market conditions. The goal of TAA is to add to portfolio returns by taking advantage of market trends or economic opportunities or to steer away from higher risk.

How does TAA work? For example, let's say a portfolio's strategic asset allocation (SAA) is 60% equities and 40% fixed income. In a recession, a portfolio manager might temporarily reduce the allocation to equities to 55% and increase the allocation to fixed income to 45%, as shown in the chart below. This is because equities are typically more volatile than fixed income during recessions, so the portfolio manager is reducing risk by increasing the allocation to bonds.

The portfolio manager would then monitor market conditions and continue to adjust the asset allocation as needed. For example, if the recession deepens, the portfolio manager might further reduce the allocation to equities. However, if the recession begins to recover, the portfolio manager might slowly increase the allocation to equities to take advantage of undervalued stocks. Typically, they stay within a pre-set range of the strategic allocation.

Shortly after the start of the Russia-Ukraine war, State Street Global Advisors, one of the world’s largest asset managers and ECF’s investment partner, considered the impact of the war on the shorter-term outlook for international markets. As a result, they made shifts away from this asset class using tactical asset allocation. With continued volatility from the war and slowing global economic growth, State Street’s tactical asset allocation team has been meeting twice a month, monitoring market and economic conditions on an ongoing basis, and proactively making tactical shifts when needed.

To summarize, with the right investment manager, tactical positioning can be part of a successful approach to managing endowment and other long-term investments. While strategic asset allocation decisions – the mix of assets in the portfolio determined by the investor's long-term risk and return goals – are the most important drivers of portfolio returns over the long term, a well-executed approach to TAA can provide additional returns to portfolios.

Discover how ECF's comprehensive endowment management approach can help advance your ministry. Contact us to discuss your investment goals.