We have evaluated more than 50 individual multi-asset strategies in the past year. What seems consistent across many of them over long periods is the limited of evidence for tactical asset allocation (TAA) skill. Put another way, if many managers had simply rebalanced their funds mechanically, rather than making shorter-term TAA adjustments, their clients would have been better off.
To be fair to managers, there is one obvious reason behind some of this: bond markets have been particularly tough to call because they have been partially rigged by central banks. This has created a free ride of sorts, driving yields so low that valuations have become unrecognisable by most metrics. However, tactical allocations to equities have also struggled. Why?
A key generalisation we would make is that many TAA processes are quite macro based. A view on macro variables such as unemployment, inflation or GDP growth often informs whether equity allocations are over or underweight. Take the Trump trade, which assumes his policies could be beneficial to materials, healthcare, inflation, employment direction and growth in the US, which in turn should benefit equities.
On the ability to forecast macro variables, evidence is tough to findRory MaguireBut macro-based TAA strategies such as this mean getting two decisions right together. Even if the asset allocator made good decisions and their odds of being right were 60 per cent per decision, linking two decisions together reduces those odds to 36 per cent. To explain: first, the TAA team are implying that macro variables such as inflation or unemployment can be accurately forecast. And second is the belief there are strong causal relationships between the economic variable (say inflation rising) and equity markets.
On the ability to forecast macro variables, evidence is tough to find, generally speaking. Take the European Central Bank survey of professional forecasters – a quarterly survey of expectations for the rates of inflation, real GDP growth and unemployment in the eurozone across several time horizons. Studies suggest these specialist forecasters are wrong more than they are right. Evidence also suggests that macro variables like inflation and GDP growth are poor causal drivers of underlying equity market returns.
Much of this latter view was formed by evaluating long-term data presented by London Business School professors Elroy Dimson, Paul Marsh and Mike Staunton. What they showed was that the higher the inflation, the lower the real returns from equities. The professors conclude: “The bottom line is that, although equities are thought to provide a hedge against inflation, their capacity to do so is limited. They are at best a partial hedge against inflation and offer limited protection against rising prices.” This is counter-intuitive, but the data is clear.
What about GDP growth and equity returns? Again, we would assume that GDP growth is a big driver of equity market returns over time. But this assumption, again, would be wrong. This is what they concluded: “Looking at 83 countries over 110 years, we find no evidence that investing in growth economies produced superior returns.” They also found a negative correlation between a country’s stock market returns and the same country’s growth in per-capita GDP.
We are not suggesting fund managers may not be skilful with TAA or even in linking macro views to asset allocation – some genuinely are. But what we would conclude is that if they use macro variables to inform their equity allocations, then they need to be exceptionally skilled. And because so many are doing it, the odds of an edge seem quite low.
Rory Maguire is managing director at Fundhouse
