The power of relative-strength investing has been well documented: Time after time, studies have shown that stocks in motion tend to stay in motion.
If you follow this blog, you know that I touched on relative-strength investing a couple of weeks ago when I wrote about trend following. Specifically, I used fashion to illustrate how the tactical allocation manager seeks to take advantage of the moves that play out in the financial markets.
It was, I think, an accurate comparison. Soon after publishing, however, I realized I’d neglected a significant part of my readership—the 50 percent of the population that is male.
At least, that’s what I surmised when Bill, a close friend who’s been kind enough to support my blogging efforts with regular readership, called me as soon as the blog went live.
“Shaggy bob?!?” he asked.
Despite Bill’s protests, I’m comfortable in my decision to blog about fashion—but I understand why he didn’t get it, and I’m determined to make amends.
This week, it’s all about football.
Come fall, Saturdays, Sundays, Mondays and sometimes Thursdays mean one thing to many American men (and women, as Bill’s wife will attest): It’s time to turn on the TV, fire up the smartphone app and check on your fantasy football selections.
What does that have to do with investing?
Sports teams, as anyone who’s ever participated in an office betting pool knows, are ranked. Players are, too, since 1969, when Oakland restaurateur Andy Mousalimas reportedly opened the first public fantasy football league to his patrons at the Kings X Sports Bar.
Both teams and players are typically ranked using the power rating. The more games a team wins or a player scores, the higher the ranking. For example, if the Packers defeat the Saints, and the Saints defeat the Colts, then one can safely say that the Packers > the Saints > the Colts. If Tony Romo scores more touchdowns than Jay Cutler, but Jay Cutler scores more touchdowns than Matt Hasselbeck, then Romo > Cutler > Hasselbeck.
Now, I don’t stand by any of those rankings, which are purely hypothetical, but they illustrate my point: The power rating is a calculation of strength relative to other teams or players. And relative-strength investing is similar; you just swap out the teams or players for investments. The better an asset class performs relative to other asset classes, the higher its ranking. The same can be said of regions and even sectors. If small-cap growth is up relative to small-cap value and large-cap growth, it has relative strength.
That may sound simple, but it’s actually much harder to reach those rankings than it may seem. Online fantasy football operators have a dazzling array of tools to quantify how well teams and players will perform, as fantasy footballers who have Jacksonville Jaguars Running Back Maurice Jones-Drew on their team will tell you; he recently fell a notch due to a fumble (or several, as Bill’s wife is quick to gloat; he’s not on her team). Similarly, asset managers who use relative-strength analysis also have quantitative tools with which they take note of an investment’s relative strength.
Results of rankings also tend to be accurate both in fantasy football and investing. Pending injury, a team or player who entered the season ranked high very often performs as expected. As for investing, I like to cite a study that divided stocks into deciles, ranked them by momentum, then looked at returns. And guess what? The portfolio with the greatest upward price momentum performed best, the portfolio with the second-greatest upward price moment performed second best, and so on.
That’s where the similarities end, though, because asset managers, unlike fantasy footballers in mid-season, can do something about the ranking information they obtain. If Jones-Drew is on your team, you’re stuck with him for the season. If Greece is in your portfolio, it can be gone tomorrow. That’s because asset managers who use relative-strength analysis are active; they actually adapt to evolving market conditions by shifting assets in response to market fluctuations.
That’s good news for investors whose asset managers use a tactical allocation strategy based on relative strength, and bad news for fantasy footballers who have Jones-Drew on their team.
If you’re in the latter, camp, though, don’t worry. Jones-Drew did fumble three times in the Jaguars recent game against the Ravens, but only one of his fumbles was lost, and his steady running game (30 carries, 105 yards) helped the Jaguars on a night that rookie Blaine Gabbert finished with just 93 passing yards. So, all things considered, he’s doing well. Better than Greece, anyway.
Tag Archives: active management
Tactical Allocation in a Nutshell
The financial services industry is cluttered with so much technical language that I often wonder how much of it is really understood by everyday investors. Being that I’m a “tactical allocation” portfolio manager, I thought I would ask some friends what they thought tactical allocation meant.
I got a variety of responses. One friend said, “It’s military maneuvering to gain a strategic advantage.”
“That makes sense,” I said.
Another friend told me he thought the way he combs his hair to cover up his bald spot was an example of tactical allocation. “Each hair gets strategically placed for maximum coverage. That’s everyday tactical allocation,” he said.
“Thanks, Steve. Good luck with the defensive combing,” I replied.
Franz, the owner of a nearby bakery, said tactical allocation to him is the strategic placement of his baked goods in the glass display case. “I put the chocolate croissants by the cash register because they’re our most popular item and we can complete the transaction faster if they’re within reach of the register,” said Franz.
Franz is a smart man. He’s maximizing his sales.
With these three random tactical allocation examples in mind, I could see that no matter how practical or outlandish tactical allocation might be, the term is invariably associated with the “strategic placement” of something to gain an advantage or protect. And that’s basically what tactical allocation means in the investment world, too.
Investopedia’s definition of tactical allocation is: “An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong sectors.”
That’s a good general definition, but there’s more you should know. For instance, there are two main tactical allocation processes. One is called discretionary and the other is systematic.
Discretionary tactical allocation is a style of management that gives the portfolio manager freedom to decide what should be done in a particular situation. For example, the manager might adjust the portfolio in anticipation of where the market’s strength will be after a government policy decision is made. This type of analysis tends to be “why and how” based, or qualitative. The process can be more predictive in nature and less disciplined than a “systematic” approach.
Systematic tactical allocation is more structural and mathematical or quantitative. Systematic approaches customarily use relative strength or trend following techniques to allocate assets towards the market’s top-performing asset classes and sectors. If it’s a global strategy, top-performing countries are tracked as well.
Another important point about tactical allocation is that it is an active management process instead of the widely accepted passive management counterpart. “Active” means the portfolio manager is actively moving assets around to try to find the best opportunities for growth, and in some cases, to reduce risk or play defense (remember Steve’s bald head).
To reduce risk or play defense, some tactical allocation strategists will go to cash in risky markets. But to do this, the manager has to consider cash to be an asset class to begin with. And believe it or not, most money managers do not consider cash to be an asset class. As such, it’s not an option. They will never go to cash. Instead they use diversification as the main form of risk control. In our opinion, this can be dangerous.
Diversification tends to reduce risk best when the general trend of the market is up. Long-term up trends are known as secular bull markets (1982-2000 was a secular bull) and long-term down trends are known as secular bear markets (1966-1982 was a secular bear). In long-term down trends, diversification may not be sufficient risk control. Why? Almost all asset classes fall during severe corrections. And cash is the only one that doesn’t. In fact, cash is the only asset class that has zero correlation with the market.
Ironically, strategists who use diversification to control risk build their portfolios with uncorrelated investments, but they never invest in the one asset class that has zero correlation with the market!
At Niemann Capital Management, we believe cash is perhaps the most important asset class investors can use to reduce risk. We use a systematic tactical allocation approach with relative strength, trend following and technical analysis to find the best opportunities for growth in low-risk markets. But when risk is high, we go to cash. We believe it’s a better risk management strategy for investors who need growth, but cannot afford to ride the markets down and then hope they recover fast enough.
About Niemann Capital Management Blog
The Niemann Capital Management blog is an information and communication site where investors, advisors and journalists can discuss with us how current world events, government policies, market fundamentals and investor buying and selling decisions are affecting investment risk in a variety of countries, asset classes, sectors and industries.
However, we want to be clear that we do not base our investment decisions on world events or government policies. We are a highly disciplined quantitative firm that uses relative strength (aka trend following) and market volatility analysis to select our clients’ investments, and we use both technical and market internal analysis to measure risk.
It should also be noted that Niemann Capital Management is not a typical buy and hold, passive, or “long only” money manager that believes diversification alone is a sufficient form of risk management. We are an active management company that uses a tactical allocation and sector rotation approach to find the best potential growth opportunities in low risk markets and we go to cash, buy inverse ETFs, and/or recession resilient investments (depending on the product) for downside protection when market risk is too high.
Our strategies are unusually flexible compared to the vast majority of the marketplace’s investment products. In fact, we think the agility of our management style enables us to more objectively discuss risk, which is a major distinction compared to firms that are perpetually bullish or bearish in accordance with how they manage money.