Empirical Asset Pricing for Tactical Asset Allocation

Abstract

Tactical Asset Allocation is short-term deviation from a long-term portfolio allocation. Portfolio managers typically combine tactical asset allocation with their period rebalancing in order to add additional return that can justify management fees. Unfortunately, the frequency of tactical asset allocation prohibits the manager from using fundamental values since these characteristics change little from month to month. This paper proposes and tests a methodology for determining a pair of asset classes to overweight and underweight that will produce a positive return spread in the next period. The model utilizes investors’ preferences for certain return distribution characteristics and the short-term persistence of these characteristics to select the best spread. Twenty years of monthly return data from five asset classes (domestic equity, international equity, fixed income, REITs, and alternative investments) were selected to represent the asset allocation opportunities of midsize institutional investors.