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Why was 2015 so Difficult for Tactical Strategists?

As we approach the end of 2015, we reflect on the ideas that worked well along with those that had less success.  For those investors who were concentrated in U.S. Large-Cap equities it appears to be a fairly flat year.  However, when you dig further into the S&P 500 Index, one can witness a far more challenging message.  When analyzing the year to date performance of the 500 individual constituents, a few top performers have driven the broad index return.  The median stock is down more than 12% below its 52-week high as depicted below: 

Even more challenging for investors was broader diversification. If you were invested anywhere else outside of the S&P 500 Index, this year can’t end quickly enough.  Energy stocks are down -12.9%, commodities are down -24.5%, and Emerging Markets are down -13.0% through November!  In fact, among the major global asset class lineup several are similarly disappointing or at the very least performing well below their historical average annual returns:

*Through November 2015 – Data from FactSet

*Through November 2015 – Data from FactSet

Diversification outside of traditional asset classes has also been difficult in 2015.  It has also been a challenging year for Tactical strategies.  Generally speaking, tactical strategies seek to generate alpha either through strategic diversification, trend following, or some combination of these two.  Based on the table above, it’s not hard to see why any kind of diversification away from U.S. Large-Cap equities has been a major drag on performance results.  Trend following has been particularly difficult given the extreme market gyrations arising in the third quarter.

To illustrate, consider the S&P 500 for the first 8 months of 2015.  Through July, it was business as usual – the market traded in a relatively tight range but found itself slightly positive on the year.  Then suddenly late in August, we saw a rapid decline of nearly 10% in just 5 days.  Indeed, many quantitatively based tactical strategies turned bearish around this time and moved to defensive positions; absolute returns on the S&P 500 were dismal at best:

*Data from FactSet

*Data from FactSet

Additionally, week-to-week volatility was elevated through the summer months pictured above. The S&P 500 alternated between positive and negative returns for 11 weeks in a row – a phenomenon that has occurred only twice since 1929:

  *Data from FactSet

  *Data from FactSet

Just as tactical strategies turned defensive, the S&P 500 surged with a return of nearly 8.5% for the month of October. Many other equity based asset classes rallied as well, leaving most quantitative strategists flat-footed and unable to capture much of the upside returns. This “whipsaw” effect prompted some investors to question whether there is still value to be added by keeping these tactical strategies in their portfolio.

 

Calendar Year Asset Class Performance – Including Morningstar OE Tactical Allocation Category

*Through November 2015 – Data from FactSet / Morningstar

*Through November 2015 – Data from FactSet / Morningstar

  

Tactical has become in many ways its own asset class – a diversifier that can help to reduce overall portfolio risk through dynamic allocation.  One having the objective to protect capital during the worst markets, while still seeking participation in the upside of broad based bull markets.  In 2008 the Tactical category outperformed the S&P 500 by over 13%, and some strategists performed substantially better.  Importantly we see from the above colored coded chart that the year to year performance of the Tactical category variation has little correlation to the rest of the asset classes.  The above table suggests that Tactical can be an effective diversifier in many different types of markets.

As we look back at the turmoil that permeated through the global markets in 2015, we see numerous opportunities for tactical strategies to add value in 2016.  Extreme divergence between the domestic and International equity markets, disruption in commodities and non-investment grade debt, and unprecedented currency swings that may soon be exacerbated by the  Fed’s action on interest rates will make for interesting conditions in the coming year.  

Given the angst and uncertainty building around the global financial markets, we continue to believe that it is more important than ever for investors to diversify into Tactical strategies for more prudently diversified portfolios.  

William Royer, Assistant Vice-President, Portfolio Manager

William Royer, Assistant Vice-President, Portfolio Manager




 

 

 

 

 

 

 

 

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