Adding Value by Tactically Repositioning the Portfolio
Many investors are so terrified by the sin of “market timing” (which certainly can't be done successfully) that they shy away from any sort of tactical positioning. This is a mistake, and it's especially a mistake in family portfolios, which are far more sensitive on the downside than on the upside.
When an asset allocation strategy has been established, it will have targets for each asset category but will also have defined strategic ranges; that is, upper and lower limits within which the portfolio will be allowed to fluctuate. After all, you can't rebalance back to the target every day!
For example, suppose the strategic target for exposure to U.S. small-company stocks is 8 percent. The strategic range might be 6.5 percent to 9.5 percent. How does an investor know whether to be at target or at the minimum or maximum exposure?
The answer is that it depends on where market valuations currently stand in relation to where valuations have been historically. If small-cap stocks are selling today at valuations that are well above long-term norms, an investor would be well advised to move toward the lower limit of the strategic range. On the other hand, if small-cap stocks are selling well below their long-term valuations, the investor might do well to move toward the upper end of the range.
This isn't market timing because the tactical moves never extend beyond the strategic ranges that have already been approved. And there has to be some thoughtful way for an investor to position the portfolio within the range. That thoughtful way should be valuation based.
Note that the most common reason tactical positioning fails has to do with the timing of the move. The mere fact that prices in some sector are above the norm doesn't mean they won't go even further above their norms—and stay there a long time. (And the same on the downside.) For this reason, families and their advisors shouldn't undertake tactical moves unless they are guided by a detailed and thoughtful outlook on the markets and on each sector that might be subject to tactical repositioning.
Many families, having read over and over that market timing doesn't work, will be skeptical that tactical positioning can add value. It's a reasonable position for a family to take, especially with a new advisor who has no track record with the family.
If you are the new advisor, you can do two things to help build street cred with the family. First, make small tactical decisions early in the relationship. Even if the family is skeptical that you will add value, they won't object to a small repositioning.
Second, focus on tactical shifts that are capital-preservation based. In other words, when prices in some sector of the market are well above normal, back off on that allocation. Because the family likely has a capital-preservation bias anyway, they are more likely to go along with a defensive repositioning—and more likely to forgive you if you're wrong!