Tactical Beta – The Client-Friendly Growth Strategy

If you’ve spent any amount of time as a financial advisor, you’ll know all too well that the investment road is full of bumps, potholes, and unexpected corners.

Now there are two ways to deal with these obstacles. You can plow through them, feeling the full effect of each jarring bump. Or, you can navigate around them to smoothen the ride for your passengers (clients). Both tactics can get you where you want to go. But the experience can be completely different.

That’s how we think about Tactical Beta.

Regardless of your investment philosophy, most client portfolios revolve around a Beta vehicle. Beta is the growth engine our portfolios need to get to their destination. However, oddly enough, these core holdings are also where client expectations tend to break down.

Passive Beta is great for set-it-and-forgetters who have the time horizon and mentality to let their portfolios ebb and flow with the market over a few decades. The road will get rough at times, but in the end their portfolio can secure the levels of growth needed to reach their financial destination (assuming they stay invested).

But the problem is many investors aren’t set-it-and-forgetters. From the risk-averse and anxious to investors with more mature portfolios in pursuit of that final surge of growth before retirement, many investors are more interested in avoiding the larger bumps in the road (as much as possible) as their portfolios grow.

Tactical Beta's Usefulness for Advisors and Investors

For clients who are better suited by a managed approach to portfolio growth, we think Tactical Beta is a great option to consider.

Tactical Beta is actively managed Beta. When markets are humming along, greater market exposure may be emphasized and when markets slow down market exposure can be ratcheted back, or strategically tilted toward areas of the market that show relative strength.

Tactical Beta is useful in client portfolios in a couple of ways.

1) More Comfortable Experience

A major benefit of tactically managed growth in a portfolio is the potential to dampen market downturns. Loss is more impactful to clients than gain. That’s human psychology. But that doesn’t change the fact that most clients need a certain level of risk exposure to achieve the growth needed to hit their financial goals.  

Tactical Beta can help reduce the pain of decline by seeking to avoid portions of it through strategic allocation shifts. This risk mitigation factor can go a long way in reducing stress, and more importantly, keeping clients invested and focused on their long-term goals.

Remember, clients don’t leave their advisors when they don’t match index returns. They leave when they’re expectations aren’t met and when they don’t feel confident in the investment strategy. Tactical Beta can help you avoid those circumstances.

2) Potential Outperformance

Like any investment, Tactical Beta strategies can outperform and underperform—it’s important to communicate that performance is never guaranteed, and that the potential for outperformance always comes with the potential for underperformance (this is why a process that clients understand is so important, which we’ll discuss in a moment). The goal is obviously to outperform their benchmark indices.

In general, potential outperformance comes from a highly hands-on and responsive allocation strategy. Based on prevailing market conditions, Tactical Beta strategies can be tilted toward more attractive segments of the market. And conversely, by reducing exposure in times of decline, Tactical Beta strategies can reduce loss in a downturn. Each function supports overall portfolio performance, with the potential to edge the portfolio above broad-based indices.

While we won’t ever advocate selling on performance alone, often times investment strategies either walk the walk or they don’t. It’s important to look not at short-term performance statistics (like the popular 3-year and 5-year figures), but at the investment process itself and total performance history of a strategy. The investment process should be clear and straightforward and performance history should serve as a validation that the strategy has been carried out within the model.

A Case for Fundamentally-Rooted Tactical Beta

Tactical Beta is a great concept, but not all actively managed growth strategies are created equal.

We believe Tactical Beta that is rooted in fundamental market pricing and sector valuation provides the most reliable performance characteristics within a portfolio. That’s because while short-term market trends can be greatly influenced by speculation and contemporary factors, like the geopolitical landscape, fundamentals tend to play out over the long term.

We use a straightforward market pricing and sector valuation process within our portfolios to align Beta exposure to long-term market cycles—a strategy that has paid off a number of times over the years.

Here are a few examples of fundamental market analysis supporting our portfolios’ growth objectives:

Positioned for the 2020 Market Turbulence

In 2020, the COVID-19 pandemic spurred a major market downturn. As a fundamentally-rooted strategist, our models were well positioned for the downturn. Prior to the pandemic, our models featured overweights in Healthcare, Technology, and Real Estate, with underweights in Financials and Energy. Our fundamental approach to Tactical Beta helped prepare our portfolios to better weather the downturn (naturally) by under-emphasizing sectors with greater perceived risk of decline and over-emphasizing sectors with higher perceived growth prospects.

Avoiding an Over-Valued Financial Sector

In 2007 the Financial sector had experienced a period of relative outperformance that was driven by an extremely high volume of mortgage loan originations. The sector became over-valued at a time when prospects for the mortgage boom were waning. AAMA eliminated its target for the Financial sector in June of 2007, ahead of the financial crisis and subsequent recession of 2008.

Buying an Under-Valued Energy Sector

In early 1999 Oil was trading at $12, down from $40. Earnings were starting to improve and growth expectations were growing. Energy represented a low-risk sector within the over-valued, growth-oriented market of the late 1990s. AAMA successfully over-weighted energy in our portfolio strategy from February 1999 through 2008.

Scenarios To Consider Tactical Beta

Like any investment strategy, one size doesn’t fit all. Some clients may be better suited by a more cost-conscious and hands-off approach to growth. However, we feel there are many scenarios where Tactical Beta may be appropriate. Here are a few to consider:

The Growth Arm of a More Mature Portfolio

Your larger clients with shorter time horizons likely can’t assume as much risk as their younger, less wealthy counterparts. But this doesn’t mean they don’t require strong growth from their core equity holdings. And while you can certainly lower risk through a higher allocation to less aggressive strategies, Tactical Beta provides an opportunity to pursue the appropriate amount of growth potential within a framework that provides the potential to reduce downside risk (even slight reductions in risk can make a big difference in these larger portfolios).

The Growth Arm of Risk-Averse Client Portfolios

Tactical Beta provides an opportunity to outperform the market, but more often it provides a less volatile growth trajectory (up and down). For investors that are particularly worried about downside protection, Tactical Beta can be a great solution that enables you to pursue comfortable growth. But as we mentioned above, not all Tactical Beta strategies are made equal. Each investment strategist is going to have their own underlying investment process. It’s important to find one that not only appeals to your investment philosophy, but the attitudes of your client. Ensure they fully understand the process that drives the portfolio. This will reduce anxiety and fear even further. 

Simplistic, Single-Investment Portfolios

UMAs are great, but let’s face it—not all of our clients need that level of diversification (or cost). Whether you’re serving one of your top client’s kids or simply a younger professional that’s in the beginning stages of wealth accumulation, some portfolios might be better served by a single strategy. Tactical Beta is a great fit for these circumstances as it provides some level of active management within a core equity position.

The investment road is full of challenges. But that doesn’t mean they can’t be managed. And what’s more, you don’t have to manage them alone. With a trusted strategist partner and well-defined Tactical Beta strategy, we believe advisors can find a Beta vehicle that fits each of their clients’ needs.

If you’d like to learn more about our fundamental investment process, click here, or reach out to our investment team today. We’d be happy to speak with you.

The information and opinions in this report have been prepared by the investment staff of Advanced Asset Management Advisors (AAMA). This report is based upon information available to the public. The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but AAMA makes no representation as to the accuracy or completeness of such information. Opinions, estimates and projections in this report constitute AAMA’s judgment and are subject to change without notice. This report is provided for informational purposes only. It is not to be construed as a recommendation to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.

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