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We have evaluated well over 50 individual multi asset strategies in the past year. What seems to be quite consistent across many of them over long periods is the limited evidence for tactical asset allocation (TAA) skill. Put another way, if many managers had simply rebalanced their funds mechanically, rather than making shorter-term TAA adjustments, their clients would have been better off.
To be fair to the multi asset managers there is one obvious reason behind some of this: bond markets have been particularly tough to call because they have been partially rigged by Central Banks since the Global Financial Crisis. This has created a bond free ride of sorts and seen yields go so low that on most metrics bond markets have become unrecognisable. But this defence does not apply to equities, and tactical allocations to equities have struggled too. Why?
A key observation (and generalisation) we would make is that many TAA processes are quite macro based. A view, say, on macro variables like unemployment, inflation or GDP growth often informs whether equity allocations are over or underweight. A good generic example today might be an overweight to equities on the back of the so-called called Trump trade. Current consensus suggests Trump’s policies could be beneficial to materials, healthcare, inflation, employment direction and growth in the US, which in turn should benefit equities.
But macro based TAA strategies, like those backing the Trump trade, involve getting two decisions right together. So, even if the asset allocator made good decisions and their odds of being right were 60% per decision, linking two decisions together reduces odds to 36%. By way of explanation: first, the TAA team are implying that macro variables like inflation or unemployment can be accurately forecasted. And second – even if forecasting skills were good – is the belief that there are strong causal relationships between the economic variable (say inflation rising) and equity markets running. Lets look at the evidence behind both linked decisions.
On the ability to forecast macro variables, the evidence is tough to find (generally). Take the ECB Survey of Professional Forecasters – a quarterly survey of expectations for the rates of inflation, real GDP growth and unemployment in the Euro area for several horizons. According to studies, these specialist forecasters get the forecasts more wrong than right. Evidence also suggests that macro variables like inflation and GDP growth are poor causal drivers of underlying equity market returns.
Much of this latter view was formed by evaluating the very long-term return and macro data studies presented by London Business School professors Elroy Dimson, Paul Marsh and Mike Staunton. What they showed, over long periods and across many equity markets, was that the higher the inflation, the lower the real returns from equities. The professors go on to conclude: “The bottom line is that, although equities are thought to provide a hedge against inflation, their capacity to do so is limited. They are at best a partial hedge against inflation and offer limited protection against rising prices.” This is counterintuitive, we concede, but the data is quite clear.
What about GDP growth and equity returns? Again, we would assume that GDP growth is a big driver of equity market returns over time. But this assumption, again, would be wrong. This is what they concluded: “Looking at 83 countries over 110 years, we find no evidence that investing in growth economies produced superior returns.” They also found that there is a negative correlation between a country’s stock market returns and the same country’s growth in per-capita GDP.
We are not suggesting that fund managers may not be skilful with TAA or even linking macro views to asset allocation – some genuinely are and we remain open minded on their capability. But, what we would conclude is that if they use macro variables to inform their equity allocations, then they need to be exceptionally skilled. And because so many are doing it, the odds of an edge seem quite low.