Topic: Financial Planning

Article written by Mel Abplanalp, Paraplanner

This week I’ll explain the differences between Strategic and Tactical asset allocation. You’ll often hear fund managers and financial advisers talking about the importance of asset allocation when investing, but what are the differences?

The natural first step is to discuss what assets are – simple answer – they can be anything! In day-to-day life, most people would describe assets as their homes, cars, boats, paintings or even their jewellery collections. In the financial world we talk in asset classes with the two main ones being equities and bonds.

The theory behind asset allocation is relatively simple: choosing a model to diversify investments in order to achieve the objectives of a fund or portfolio. There are countless papers on the theory of this and it is recognised as an important part of the process of building a portfolio. This could be an investment return target or a target to manage risk effectively. Managers will not only break down by asset classes but also by geography or sector. For example, you could invest 10% in UK equities, 5% in overseas property etc etc.

Strategic Asset Allocation

This is more of a long-term target of how you would like the fund to be run now and in the future. Its the bare bones structure of the fund and is often a starting point to fund construction. As an example, the Buckingham Gate Balanced Portfolio’s allocation is 5% cash, 32% bonds (of which 16% are UK government and 16% UK corporate), 25% UK equities and 38% Global Equities (20% US, 6% Europe, 4% Japan, 4% Asia and 4% Emerging Markets).

Crucially it doesn’t consider what is happening in the short term. Square Mile, who currently run our portfolios, review the strategic asset allocation of all our portfolios every three years.

Tactical Asset Allocation

The main difference here is about being reactive. Tactical asset allocation is about changing to suit what is happening in the shorter term. Tactical changes normally happen very quickly and could be in reaction to unforeseen events. The recent market drop at the start of the pandemic last year is a fantastic example of something that you couldn’t account for in a strategic asset allocation and could merit fast-paced changes being made. Our Buckingham Gate Balanced Portfolio has the flexibility to change the equity portion from 63% up to 68% or down to 53% (5% above or 10% below the equity allocation within the strategic model) and its this 15% difference that represents the tactical element. When valuations are seen as cheap, this would be when equities would be at 68% but when things are more volatile this would be when equities are at 53%.

These two different methods are therefore complimentary and can be used in tandem to produce the best returns or a smoother journey.

I’ll finish off with a real-world example here. I’ve often likened asset allocation to being similar to making a cake… bear with me… Strategic asset allocation is your go to recipe; you have all the ingredients that you need at home and you are making the cake for the perfect recipient on the perfect day.

My mother-in-law makes the perfect chocolate brownies, they come out the same every time & are exactly how she likes them. The recipe was passed down the generations and she has not changed it in years. Tactical allocation is for those days that you have pecans in the cupboard instead of walnuts and the normal recipe just will not work. In the case of my mother-in-law’s brownies – she had to change her cooking time when her oven started to play up and the temperature dropped a few degrees. These are the things that you just can’t plan for.