Con: tactical asset allocation: a sure-fire investment technique or just a fad?

• Author: Jacques, William E.

Tactical asset allocation: a sure-fire investment technique or just a fad?

A not-so-secret formula

Can you really make effective investment decisions using tactical asset allocation? This investment specialist thinks not, and says the Law of Large Numbers is what makes the technique look successful.

On a recent walk around our offices located next to Faneuil Hall in Boston, we found a T-shirt vendor, looking rather forlorn. He was literally giving away a truck-load of T-shirts with "Portfolio Insurance" inscribed across the chest. Asset managers sometimes do turn lead into gold, so we took his inventory and printed "Tactical Asset Allocation" on the backs of the shirts. Now, they're selling like hotcakes.

Indeed, tactical asset allocation (TAA) is very much like the flip side of portfolio insurance. One reason TAA is now such a hot topic is that it provides an answer to the ubiquitous question from senior management: "What are we doing to protect against another October 19 market decline?"

Tactical asset allocation vendors whose models reduced equity exposures to low levels before the October 19 decline are knocking on doors to sell their magic elixir. However, all TAA models aren't equally prescient. The following analogy may serve to put into perspective the offering of those who come marketing their wonder cures.

Imagine a room full of monkeys. Each of them participates in a game to try to predict the direction of the market. There are 1,000 monkeys in the room. At the end of 10 predictions, there is one monkey with a perfect record of 10 straight calls, 10 with nine out of 10 correct, and 44 with eight of 10 correct.

What happens next? The monkey with the perfect record starts his own investment firm. The monkeys with nine out of 10 correct calls get recruited by the larger investment firms who are eager to get into the tactical asset allocation game, and those with eight out of 10 are hired by those companies that can't afford the "top" talent. Eventually, all of these monkeys will knock on your door to market their impressive past deeds. The unlucky monkeys--the 945 with fewer than eight correct predictions--stay home.

However, there is now a new breed of monkey, even more clever. Rather than make predictions, these monkeys try to figure out a system to predict the market. After many, maybe thousands, of tries, they come up with a scheme that would have predicted the last 10 market moves correctly, or, if they are less ambitious, only...