Seizing tactical investment opportunities can improve a portfolio’s performance significantly without meaningfully changing its risk profile. Successful tactical investment requires taking well-judged risks on incomplete information. While we may not get it right every time, we are confident that our investment process injects portfolios with additional sources of returns, which are particularly useful in today’s environment of low interest rates.

Our overweight allocation to EM sovereign bonds (denominated in US dollars) has been one of our most successful tactical positions in 2020. When global markets reacted to the spread of Covid-19 earlier this year, EM sovereign bond prices fell dramatically relative to the price of US government debt. While it’s tempting to pick up asset classes after such a steep fall, it’s also crucial to consider the near-term risks. Following decisive action by global governments, central banks and international institutions such as the International Monetary Fund to stabilise economies and financial markets, we introduced an overweight allocation to EM sovereign bonds in late April.

As fears of widespread defaults among EM countries faded over the summer our overweight allocation generated positive returns. By the end of July, EM bonds had gained more than 15%. While valuations have returned to more typical levels, current yields remain attractive and we have maintained our position. The return outlook is lower than it was in April, but so are the risks.

We are consistently monitoring all asset classes for their attractiveness along these drivers, while closely observing the macro and risk backdrop.

Our TAA decisions boosted portfolio returns during 2020. We started the year with an overweight allocation to equities. After strong initial performance, our investment process was put to the test in March as the global market correction weighed on the performance of our tactical decisions. Yet we maintained our allocations because we believed prices already reflected the economic fallout, and we expected them to pick up as support measures kicked in.

We used cheaper valuations to selectively add to our credit holdings in April. Portfolios benefited from the market’s rapid recovery across equities and credit throughout the summer, when we initiated an overweight in EM equities. Steadier market conditions in the second half of the year helped our TAA enhance performance. The most significant positive contributions came from our overweight positions in gold (which we reduced in June), US technology stocks (which we reduced in June and closed in December) and EM sovereign bonds. An overweight in local currency EM bonds earlier in 2020 detracted from returns.

TAA can be approached in various ways and it can mean different things to different people. We use these shorter-term investments to enhance the returns of a diversified portfolio. These decisions always fall within our SAA framework and are not an independent activity. The unexpected happens more than you think and by maintaining the integrity of your SAA we don’t compromise our focus on obtaining your long-term goals. For example, an underweight allocation to a certain asset class does not mean we’re recommending avoiding that part of the market altogether.

When we overweight one asset class, we reduce our allocations to another. This tilts your portfolio away from areas where we perceive greater risks or lower opportunities and towards areas where we believe there are better risk-adjusted returns. When asset prices fall, the TAA is not a way to avoid drawdowns, but an attempt to mitigate them.

Our TAA involves asset classes and sub-asset classes only. While selecting individual investments, such as equities, can be an exciting exercise, it’s not part of our TAA process. In fact, instrument selection is generally only responsible for 10% of your portfolio’s risk and return, with TAA accounting for 10% and SAA for 80%.

The global economy is at an early stage of recovery following the shock caused by the Covid-19 pandemic, with central banks and governments around the world implementing record stimulus measures. This situation provides a positive backdrop for risky assets at the start of 2021, and for equities in particular. We express our positive outlook by overweighting US and emerging market (EM) equities and selected credit asset classes.

We’ve reduced our allocation to euro government bonds, which are unlikely to offer a decent return and could fall in value. We complement our tactical allocation decisions with diversifying positions. Notably, we have an overweight allocation to US Treasuries, both nominal and inflation-protected, which are offering better diversification value than euro government bonds due to their higher yields.

We’re continuously adjusting our allocations to different asset classes to reflect the investment environment

N = Neutral weighting of the asset class within the SAA. Source: Quintet as at December 2020.

Investing with a long-term perspective is the best way to achieve your financial goals, but that doesn’t mean you should ignore shorter-term investment opportunities. That’s why we combine our strategic asset allocation (SAA) framework with shorter-term tactical asset allocation (TAA) decisions. We overweight asset classes that we believe offer an attractive risk-adjusted return outlook over the next six to 12 months and underweight those that look less appealing. In order to identify tactical opportunities, we combine our analysis of the global economy and investment environment with specific measures of the prospective returns from the major asset classes.