Reflections On The Past Decade

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"Not so Fast"

I've read a number of articles recently about the under-performance of Tactical Asset Allocation. I'm going to delve into that issue in considerable detail in this blog post. Those who are successful market timers and dedicated shepherds in shifting asset allocations within their portfolio should skip this article. To all others, I say "not so fast" and I've got numbers to back that up.

Let's start with a question. "If forced to make a choice between the safety of your money and return on investment, which would you choose?" Most of us have a "recency" bias which creeps into our investment decision making depending upon where we are in the full market cycle. Given a few years of elapsed time from a Bear Market, we become more concerned about return on investment than protecting ourselves from the next Bear. Fear is a far more immediate emotion so it takes just a few quarters in a Bear Market to forget about the Bull and worry about safety. Your answer to the question is likely to be tempered by the time elapsed from the last Bear Market.

We are going to compare five investment strategies (all of which include dividends):

  • Buy and hold the S&P 500
  • Buy and hold the Vanguard Balanced Index Fund (60% equities, 40% fixed income)
  • Buy and hold the Best Active Managers
  • TAA Enhanced Best Active Managers
  • TAAS Global Strategy

You will recall that in my previous blog, "TAA versus Active Fund Management", the Best Active Managers strategy bought and held the funds managed by the top Active Manager in each of Morningstar's five categories. The TAA Enhanced Best Active Managers strategy selected the three top performing BAM funds each month or went to cash if all were performing negatively.

Return On Investment

I will readily stipulate that Tactical Asset Allocation ("TAA") has provided lower returns than buying and holding the S&P 500 for the past several years. In fact, this table of annual returns for the past ten years demonstrates that the S&P 500 has outperformed all other strategies for the last five years in a row.

However, the TAA Global Strategy outperformed both the S&P 500 and the Vanguard Balanced Index Fund for the previous five years and the Best Active Managers strategies for four of the previous five years. We'll look at the compounding effects of these returns in a moment.

"my personal investment screening process begins with finding investments with acceptable drawdowns before ever looking at returns"


This table, showing the worst total drawdown during each calendar year, covers the same ten year period. Here we see that the TAAS Global Strategy has significantly outperformed the S&P 500 for ten of the past ten years, and the other strategies for at least seven of the past ten years.

I note a few stomach-churning declines of 20%+ in the S&P 500, Vanguard Balanced, and Best Active Managers which were actually compounded by continuing from one year into the next. For many investors, stomach-churning returns lead to selling out when the decline is well advanced and then trying to get back in after the recovery has also well advanced.

This is why, again and again, I try to drive home the point that investors should know the drawdowns before investing based on seemingly attractive returns. In fact, my personal investment screening process begins with finding investments with acceptable drawdowns before ever looking at returns.

Putting It Together

Our final table summarizes investment returns and safety across the full market cycle starting with the beginning of the Bear Market in September 2007 through the ensuing recovery and Bull Market through 2016.

The Compound Annual Growth Rate for the TAAS Global Strategy handily beats the whole lot. On a risk adjusted basis, the TAA Enhanced Best Active Managers strategy comes in a clear second also handily beating the other three. A look back at the first table shows that while the TAAS Global Strategy, and to a lesser extent the TAA Enhanced Best Active Managers, rarely outperforms the S&P 500 on the upside, it avoids the big losses on the downside. This brings home a critical lesson ... it is not high returns but avoiding losses which drives this out-performance.

Maximum Monthly Drawdown, requires an explanation. This is quite simply the maximum percentage by which your monthly statements show the account value has declined from the peak statement. During a Bear Market, this will persist across months and even years. So if your statements show a peak value of $100,000 in Month 1 and a value of $50,000 in Month 13, the drawdown is 50%.

The maximum drawdown for the S&P 500 was nearly 8 times as high as the TAAS Global Strategy. The drawdown for the Vanguard Balanced Index Fund was 5 times as high. The drawdown for the Best Active Managers was 4 times as high. Large drawdowns dig large holes. Setting aside the psychological issues, a portfolio which has declined by 50% must double in value just to get back to its peak. That takes time and burns through gains which would otherwise be creating new value in the portfolio.

The low Monthly Standard Deviation in returns indicates that the TAAS Global Strategy is not using leverage and increased risk exposure. In fact, it is just the reverse ... out-performance is based on much lower portfolio volatility. It reminds me of the childhood fable: "The Tortoise And The Hare". Even though I consider myself an astute investor, I have been burned far too many times by the Hares.

How Much Can I Take Out?

The final statistic is the Sustainable Withdrawal Rate which assumes the investor's worst nightmare: you invest your money and the market immediately heads south into a Bear Market. In calculating the Sustainable Withdrawal Rate, we deduct the Maximum Monthly Drawdown from the principle, apply the Compound Annual Growth Rate to the remaining balance, and finally, assume we can withdraw just 2/3 of the return. Clearly, both Compound Annual Growth Rate and the size of Maximum Monthly Drawdown is a big factor in sustainability.

Calculation for S&P 500: (($100,000 * (1.0 - .508)) * 0.069 * 0.6666) / $100,000 = 2.3%

Markets Do Cycle

Earlier, I referred to the effect of "recency bias" in viewing our investments. It is the very fact that every Bull Market in history has been followed by a Bear Market (and vice-versa) which makes it imperative that we deal with "recency bias" by holding onto our long term objectives. For those who are not market timers and dedicated asset allocations, this means following an investment strategy which is designed to adapt to market conditions during a full market cycle.

"The hurrier I go, the behinder I get.”

You can retain personal control and custody of your investments without having it occupy your every waking hour. Tactical Asset Allocation will not catch exact tops in Bull Markets or exact bottoms in Bear Markets but it will stick with persistent positive trends and get out of the way of persistent negative trends. Tactical Asset Allocation will pick and choose among the best performing assets and get out of the way when there are none.

The TAAS Global Strategy does it better than any Tactical Asset Allocation strategy I have found. That is why a substantial portion of my family's assets are invested in the TAAS Global Strategy.

Earl Adamy


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1 thought on “Reflections On The Past Decade”

  1. Earl, once again your explanation of the primacy of drawdown when factoring returns is superb. We are all subject to “recency bias”, which is why a dispassionate investment strategy such as TAAS works so well. Thanks!

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