Tactical asset allocation in a changing market

Positioning your portfolio to meet long-term financial objectives requires strategic planning structured around your goals, time horizon and risk tolerance. Yet as capital market dynamics ebb and flow, opportunities may emerge to refine your portfolio’s positioning. Tactical asset positioning can help you take advantage such opportunities.

Tactical asset allocation

Tactical asset allocation is a way to fine-tune a portfolio to take advantage of the fact that capital market results vary in the short term. In today’s market, for example, factors such as declining inflation, moderating interest rates and improving corporate earnings may represent opportunities to implement short-term portfolio adjustments.

At the broadest level, investors have seen notable variation in recent years’ stock and bond performance.

“In the first half of 2024, the equity story was all about technology stocks,” says Rob Haworth, senior investment strategy director for U.S. Bank Asset Management. “However, as interest rates declined in mid-2024, other sectors began gaining ground.” By contrast, bonds were down modestly over the year’s first half, but rebounded in the third quarter. Bond returns rise when interest rates fall.

Tactical investment opportunities in today’s market

While U.S. Bank Asset Management currently advises investors to consider a neutral weighting between equities, fixed income and real assets, Haworth says there are some tactical opportunities to explore.

“Specific tactical moves designed to capture a market opportunity within any of those asset classes require investors to be nimble and willing to move quickly in and out of specific positions,” says Haworth.

Opportunities for tactical asset allocation in today’s environment

• Non-government-agency-backed residential mortgage bonds: Non-taxable fixed-income investors may want to consider residential mortgage-backed securities (MBS) not backed by the government, which have strong fundamentals and offer competitive current income. “These securities are particularly attractive given low mortgage loan balances relative to home values and strong incentives for homeowners to remain current on low fixed-rate mortgages they locked in prior to the onset of higher interest rates,” says Haworth.
• Municipal bonds: Tax-aware investors can earn extra potential returns by slightly extending maturity profiles in municipal bond holdings and incorporating a modest allocation to high-yield municipal bonds. Haworth notes that while adding risk, “high yield municipal bonds tend to have lower default rates than we see in the corporate high-yield market.”
• Insurance-linked securities: Tied to the sale of reinsurance products, these securities can offer highly competitive income streams in the current environment for certain types of investors, particularly within trust portfolios.

Dollar-cost averaging

The second situational strategy is dollar-cost averaging. As you accumulate cash in your portfolio, investing it into asset classes with higher returns, such as equities, is key to meeting your long-term financial goals. Dollar-cost averaging may increase your comfort level with equity investing during volatile times. This strategy involves investing a portion of your cash balance into the target equity portfolio at regular intervals, rather than investing in a lump sum.

“With interest rates falling, particularly on shorter-term savings vehicles, investors need to be more diversified to achieve their objectives,” says Haworth. “With the market at all-time highs, investors may experience regret if they invest just before the market pulls back.” Haworth says dollar-cost averaging smooths out “not just the market’s bumps, but potential feelings of regret.”

Portfolio rebalancing

The third situational strategy addresses times when asset prices move in different directions and at different speeds. These return variations can cause your initial portfolio allocations to drift from your long-term strategy. Rebalancing your portfolio from time to time may help you achieve your investment objectives.

“We’ve seen a big performance gap between stocks and bonds and between domestic equities and international equities,” says Haworth. This may create an opportunity for investors to shift some assets to help better balance a portfolio consistent with one’s goals.

“If you have significant positions in assets that have become expensively valued, you may want to reposition those holdings as a way to help manage portfolio risk,” says Haworth.

The table below details annual performance across a variety of asset classes (represented by market indices) for the past five years.

Don’t lose sight of strategic portfolio positioning

Situational strategies such as tactical asset allocation have their place, but the primary driver of your asset mix should be long-term, strategic positions that are designed to be held over time to meet your specific investment objectives.

The core components of a diversified portfolio likely include:

• Equities. Over the long run, stocks have generated strong returns, driving portfolio gains over most business cycles. Stocks can be volatile and suffer periodic declines, but they remain crucial return-drivers that can help you meet your long-term goals.
• Fixed income. Over time, high quality bonds provide important portfolio diversification and stable current income. These two features make bonds a key component of diversified portfolios. While stock and bond prices don’t always move in opposite directions, they do act differently over time and provide investors with opportunities to rebalance into stocks after a stock market correction.
• Real assets. Real assets such as real estate, global infrastructure, and commodities can help balance a portfolio predominantly made up of stocks and bonds.

Maintain a well-positioned portfolio

Tactical adjustments, dollar-cost averaging and rebalancing your portfolio positions can align your asset mix with your goals, time horizon and risk tolerance.

Your wealth management professional can help you blend and select situational strategies to keep your portfolio on target to help meet your long-term investment plans and goals.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe and is a subset of the Russell 1000 Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap Growth Index measures the performance of the mid-cap growth segment of the U.S. equity universe. It includes those Russell Midcap Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell Midcap Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. It includes those Russell Midcap Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index includes approximately 1,000 companies representing the stock markets of 21 countries in Europe, Australasia and the Far East (EAFE). The MSCI EAFE Value and Growth Indices covers the full range of developed, emerging and All Country MSCI Equity Indices. The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. The Dow Jones Equity All REIT Capped Index is designed to measure all equity REITs in the Dow Jones U.S. Total Stock Market Index, as defined by the S&P Dow Jones Indices REIT/RESI Industry Classification Hierarchy, that meet the minimum float market capitalization (FMC) and liquidity thresholds. The FTSE Global Core Infrastructure 50/50 Index and FTSE Developed Core Infrastructure 50/50 Index give participants an industry-defined interpretation of infrastructure and adjust the exposure to certain infrastructure sub-sectors. The constituent weights for these indexes are adjusted as part of the semi-annual review according to three broad industry sectors — 50% Utilities, 30% Transportation including capping of 7.5% for railroads/railways and a 20% mix of other sectors including pipelines, satellites and telecommunication towers. Company weights within each group are adjusted in proportion to their investable market capitalization. The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities. The Bloomberg U.S. Municipal Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar denominated, fixed tax-exempt bond market. The index includes state and local general obligation, revenue, insured and pre-refunded bonds. The ICE BofAML U.S. High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.