Your colleague is dating a guy who works at one of America’s biggest investment firms. They invite you to a party. The parking lot is filled with Maseratis, Ferraris and Teslas. The women are wearing Hermes, Prada and Gucci.
Your colleague introduces you to a guy named Angus. He runs one of the company’s biggest investment funds. You aren’t sure what to talk about, so you ask about his job. “It’s technical,” he says. “I run a Tactical Asset Allocation Fund.” Angus says his fund differs from most mutual funds, which usually stick to a specific style. In other words, some mutual funds include just large U.S. stocks. Others focus completely on emerging market shares. Bond market funds focus just on bonds, while balanced mutual funds contain stocks and bonds.
“I’m not so restricted,” says Angus. “I keep my finger on the pulse of the global economy. We look at price trends and economic fundamentals. If our analysts say emerging market stocks are going to have a really good month, I shift the fund’s holdings to capitalize on that. If, in the following month, we think U.S. stocks will drop, but an alternative asset class will rise, we’ll sell plenty of U.S. stocks. Then we’ll invest the proceeds where we think the smart money is going next.”
You’re embarrassed to admit that you don’t follow market forecasts or trends. You invest in a diversified portfolio of low-cost index funds. Would it be better to invest with a guy like Angus? After all, plenty of people do. For example, retail investors have $13.5 billion in the Beach Hill Total Return fund (BHTAX). There is a whopping $18 billion in the PIMCO All Asset fund (PALPX).
Unfortunately, tealeaf readers might perform better. Over the past five years, these two funds averaged compound annual returns of 3.45 percent and 4.71 percent respectively. Such low returns, collectively, cost their investors millions.
Tactical Asset Allocation funds work well for investment firms because they charge high fees to naïve clients. The Beach Hill Total Return fund costs 1.77 percent per year. The PIMCO All Asset fund costs 1.05 percent per year. In other words, they each cost at least 20 times more than a low-cost index fund. Such fees help their managers make Ferrari and Tesla payments. But investors get ditched on a road of broken dreams.
For example, Morningstar tracks the performance of more than 300 Tactical Asset Allocation funds. Just 176 of them have 5-year track records. These are the survivors. Funds that don’t perform well usually disappear.
Over the 5-year period ending July 19, 2019, the surviving Tactical Asset Allocation funds averaged a compound annual return of just 2.94 percent. None of them beat the U.S. stock market index, which averaged a compound annual return of 10.22 percent. If the managers knew that U.S. stocks would perform this well, they would have stuffed their funds with U.S. stocks.
Agnus, however, might say this comparison isn’t fair. He might say investment funds should be more diversified instead.
Don’t tell Angus this (unless you want champagne on your shirt) but Vanguard’s Balanced Index (VBIAX) beat almost 99 percent of Tactical Asset Allocation funds over the past five years. With about 60 percent in U.S. stocks and 40 percent in U.S. bonds, it averaged a compound annual return of 7.51 percent. Only two Tactical Asset Allocation funds managed to keep pace: The Sector Rotation Fund (NAVFX) averaged a compound annual return of 7.77 percent, and the Cavalier Growth Opportunities Institutional fund (CATEX) averaged 7.68 percent.
I also compared a portfolio split into three equal parts: one-third in a U.S. stock index, one third in an international stock index and a third in a U.S. bond market index. It averaged a compound annual return of 5.08 percent over the 5-year period ending July 19, 2019. That beat 90 percent of the surviving Tactical Asset Allocation funds.
A portfolio with 55 percent in a U.S. stock index, 25 percent an international stock index and 20 percent in U.S. bond index earned a compound annual return of 7.1 percent over the five years ending July 19, 2019. That beat almost 99 percent of surviving Tactical Asset Allocation funds tracked by Morningstar.
There’s a lesson in this madness. These fund managers are constantly trying to find the best asset classes. But nobody, with any degree of consistency, can predict the future. That’s why it’s best not to try. Build a diversified portfolio of low-cost index funds. Don’t ever speculate. Then, if you’re so inclined, you might buy your own Gucci clothes or Tesla car. That always beats paying for somebody else’s status piece.
Investment Forecasting Doesn’t Work
Tactical Asset Allocation Funds: 5 Years Ending July 19, 2019
|Portfolios||5-Year Average Return||$10,000 Grew To…|
|Tactical Asset Allocation Funds||2.94%||$11,559.01|
|100% U.S. Stock Index||10.22%||$16,266.80|
|60% U.S. Stock Index, 40% U.S. Bond Index||7.51%||$14,362.97|
|33% U.S. Stock Index, 33% International Stock Index, 33% U.S. Bond Index||5.12%||$12,839.53|
|55% U.S. Stock Index, 25% International Stock Index, 20% U.S. Bond Index||7.01%||$14,033.21|
|5-years ending July 19, 2019 - Source: Morningstar.com Note* Morningstar’s published performance data on Tactical Asset Allocation Funds doesn’t exceed 5 years|
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas