Chapter 7. Tactical Asset Allocation The Devil and the Details
Investing demands that investors make a fundamental choice: embrace the market portfolio or opt for something else. Most investors choose something else, which by definition translates into crafting an asset allocation policy that, consciously or not, differs from the market's allocation.
As we discussed in the previous chapter, the basic task of managing asset allocation—rebalancing—is necessary if we intentionally modify what's available passively in the market portfolio. There's not much point to customizing an asset allocation strategy only to abandon it to the market's whims for managing the mix. If there was reason to doubt or second-guess the market's asset allocation in the initial design of an investment strategy, no less is required for managing the asset allocation through time.
Rebalancing, then, is the required task that flows directly from embracing an asset allocation that departs from the passive mix available in the market portfolio. Rebalancing here is defined as responding to the asset allocation changes imposed on the portfolio by the fluctuations in the capital and commodity markets. As such, rebalancing is reactive and seeks to manage the market-driven shifts in portfolio structure.
If rebalancing is managing asset allocation by reacting to market events, what do we call changes to the portfolio structure that are based on forecasts? Sharpe (1987) distinguishes between strategic asset allocation (SAA) ...