Pidä taktiset vedot pieninä

Here with me to explain is our director of personal finance Christine Benz.

Christine, thanks for joining me.

Christine Benz: Jason, it's great to be here.

Stipp: We do know that investors are probably feeling pretty good after 2013, but we also have some data that indicates that they're feeling pretty good and making some portfolio moves because of that. What does the data tell us about where investors' heads might be right now?

Benz: We regularly monitor fund flows. We're able to see flows into mutual funds and exchange-traded funds as well as flows out of those products. What we see is that investors seemed to be in risk-on mode. So the market has been pretty good when you look over the past five years, very strong returns across a number of asset classes. In general, investors appear to be comfortable taking risks.

We've seen very strong flows into equity funds at large, especially into some of the riskier categories. We've seen very strong flows into international funds, and emerging-markets funds specifically have seen some of the biggest flows across equity funds.

We've also seen investors appear to be feeling pretty comfy with risk in the bond world as well. Investors are shunning interest-rate risk. They're selling long duration bonds, they're selling intermediate-term high-quality bonds that they perceive to be interest-rate sensitive, but they're buying more credit-sensitive bonds. The bank-loan category, for example, has really amazed us all in terms of its asset inflows. It's gathered something like $60 billion over the past year. The nontraditional bond category, which is a newer category for us, has seen over $50 billion in new flows over the past year. High yield hasn't seen quite as much in terms of new inflows, but inflows were still positive in 2013 as well.

Stipp: If we've seen money going into some of these areas--some of them even newer areas or more esoteric areas like bank loans--that's going to change the composition of people's portfolios. We think long-term investors are in strategic portfolios. They find a good asset allocation. They rebalance back to that allocation. But if we see people going into some of these other areas, how does that mesh or not mesh with being a strategic investor?

Benz: Of course, it's hard to generalize about what a lot of investors are doing with their portfolios. But my concern is that if investors are positioning their portfolios in the way they appear to be, maybe they are making some tactical bets, and specifically, it looks like a lot of people are banking on this current economic recovery to continue for the foreseeable future, because a lot of the categories that investors are buying are, in fact, very sensitive to that current economic recovery. They'll do great if it continues. But if it sputters a little bit, their portfolios may not be positioned as well.

So my concern is that investors are putting a little bit of a tactical emphasis on their portfolios, and maybe they are not thinking about that well-diversified strategic asset allocation plan, which absolutely would call for holding a position in high-quality bonds, for example, which maybe wouldn't perform as well as in an economic recovery or if rates go up, but would certainly hold their ground well if the economy starts to sputter a little bit or if this current rally starts to peter out.

Stipp: There could be a group of investors who are straying to be more tactical and maybe not intending to do so. There might be another group of investors who say, hey, maybe I want to be tactical right now. Maybe I want to continue to ride this rally or I want to get out of bonds, because I don't want to take a hit there. This could sound good in theory, but there are also some problems with executing a tactical asset allocation.

Benz: It sounds super in theory, and it doesn't seem like it should be that hard. I think that's why people are attracted to it. Especially if I bias it a little bit toward safety and valuation, it seems like maybe a perfectly sensible thing to do. But the fact is, when we look across the performance of tactical mutual funds, what we see is a history of not-so-great long-term performance relative to just a strategic buy-and-hold strategy.

Compared to, say, a plain vanilla index--like a 60% equity, 40% bond portfolio--those tactical asset allocators haven't done so well, and I think that the recent past provides a couple of great examples of how this can be difficult to pull off. If you think back to two or three years ago, there was a lot of hand-wringing going on already about what could happen with interest rates. A lot of people were saying, me included, maybe you ought to shorten up.

Well, lo and behold, if you had stuck it out in some sort of intermediate-term bond fund, you would have been better off over the past three years than if you had, in fact, gotten short.

I think that's a great example of how, even though it seems like an obvious thing to do, those bets don't always play out.

The other thing is that, at the outset of 2013, you had some very smart managers saying that the market looked really expensive. Well, lo and behold, the market surprised almost everyone on the upside in 2013. The equity market generated much more robust gains than many investors expected.

Stipp: Not only do you have to be right, but you also have to have your timing right, essentially to really execute this well.

Benz: That's right.

Stipp: This is not to say, though, that you can't have a strategic portfolio plan, but also be sensitive to the fact that there are inefficiencies, perhaps, in the market that you could take advantage of, or you could protect yourself a bit more on the downside.

You have few ideas of how you can blend a tactical approach into a more strategic asset allocation approach. What are some of those ideas?

Benz: The first one would be simply to not just buy and hold, but buy, hold, and rebalance. Periodically scale back your most highly appreciated positions and tip the money into parts of the portfolio that haven't performed as well. As we look back on the past five years, for a lot of investors, that's going to mean selling equities, and it probably will mean buying bonds instead. That's not something that a lot of people feel comfortable with. But I think over long periods of time, that disciplined rebalancing program will help reduce risk in the portfolio. That's, I think, a great way to do a "chicken" tactical asset allocation play.

Another thing you can think about … we've seen a lot of investor enthusiasm for passive products, but if you have actively managed funds in your portfolio, where maybe the manager is paying attention to valuations in the market, that can be another way to add a little bit of a tactical overlay to your portfolio.

Stipp: Christine, it seems at times of market outperformance and also underperformance, it is easy to stray from a plan, but sticking to that strategic asset allocation, maybe being a little tactical on the margins, could be good for investors. But they probably should keep it simple at the end of the day.

Benz: Keep it simple and don't go overboard with the tactical plays.

Stipp: Thanks for joining me, Christine.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.