An Introduction to Tactical Investing | Podcast | Jeff DeMaso and Josh Jurbala

Making Tactical Practical: An Introduction to Tactical Investing

December 2, 2020

Episode Description
FEATURING Jeff DeMaso and Josh Jurbala

Tactical investment strategies may seem confusing or complex; there are a lot of misconceptions about how they work and how they fit into a long-term investor’s portfolio. We’re here to clear things up.

Join Director of Research Jeff DeMaso and Quantitative Investments Manager Josh Jurbala for the first part of our multi-episode look at tactical investments. They explain the terminology and provide an engaging overview of this ever-evolving investing methodology.

In this insightful conversation, Jeff and Josh discuss:

  • What do we mean by “tactical,” exactly?
  • The difference between quantitative and fundamental investment analysis
  • Who should invest in tactical strategies?
  • Aren’t these strategies just market timing?
  • How Adviser Investments’ tactical portfolios operate
  • … and much more

This disciplined, rules-based investment approach offers a solution for investors seeking to remove the emotional component from decision-making in their portfolios. It’s not for everyone, but is tactical for you? For more, click above to listen now!

To hear part 2, “A Tactical Take on High-Yield,” click here.

Episode Transcript

Jeff DeMaso:

Hello and welcome to another The Adviser You Can Talk To Podcast. I’m Jeff DeMaso, director of research here at Adviser Investments and today I’m joined by my colleague, Josh Jurbala, our quantitative investments manager. Josh, welcome back to the pod.

Josh Jurbala:

Hey Jeff. Good to be back.

Jeff DeMaso:

Happy to have you. At Adviser Investments, one of our longstanding investment principles is that spending time in the market is vital to investment success. It might be a surprise to learn that we manage several tactical strategies and Josh leads our efforts on that front. Now I think there’s a lot of confusion and misconceptions around tactical strategies so Josh and I wanted to have a conversation about tactical investing.

Jeff DeMaso:

Josh loves to go deep, so please just consider this part one in a series of conversations we’ll have on the topic and in future episodes, we’ll dig into why and how someone should use tactical, as well as looking at some of our trading strategies and we’ll also pull in some of our colleagues to broaden this conversation out.

Jeff DeMaso:

But today we’re going to start with a primer on tactical investing, what it is, how we think about it and what investors should expect from tactical investing. I’ve said the word “tactical” far too many times without providing a clear definition of it so let’s start right there, Josh, what do we mean when we say tactical?

Josh Jurbala:

Yeah. The short answer is tactical strategies are an investing style or an approach used to actively trade and adjust a portfolio allocation. Most investors, most of our clients, they hold most of their assets in what we would call a core portfolio or some might refer to it as a buy-and-hold approach. You often hear that term. A core portfolio holds a steady allocation that has set target weights with fewer changes made over time. We might rebalance once a quarter, once a year or you might trade or adjust exposures and you even might over- or underweight certain asset classes, but these changes are less frequent compared to a tactical strategy. Basically, to sum it up, the two distinct characteristics of a tactical strategy as we approach it, are they actively trade over shorter time periods and they’re systematic or rules based. That’s kind of the feature of tactical. They trade in and out of positions more frequently and they make more changes than would be made in a traditional buy and hold core portfolio.

Jeff DeMaso:

Okay. I guess at risk of over simplifying here, does tactical just mean short term and more frequent?

Josh Jurbala:

Yeah, kind of, but there’s a little bit more to it than that. It comes down to strategy versus tactics. Just those base words. These terms were first used in the military, but they’re also widely used to describe any type of plan such as a business plan or an investment plan. And basically it means that strategy is the long-term plan or set of guidelines to reach your overarching long term goals and tactics are the specific actions and the shorter term objectives set to reach those long term goals. A simple example is your long term goal could be to save for retirement and your strategy is to maximize growth by investing in stocks until retirement and the tactics to reach that long term goal would just be the investments and the weights you choose to hold in your portfolio and how often you trade or change those holdings and weights. In my mind, tactics just means having a plan of action in place to keep you on track towards your long term goals.

Jeff DeMaso:

Now, that’s really an interesting way to frame it, Josh, because we often hear tactical investors and strategic investors is opposing or opposite sides of the spectrum, but the way you talk about it, it sounds like maybe they’re a little bit more complimentary.

Josh Jurbala:

Yeah, exactly. And there’s actually a great quote from the Chinese philosopher, Sun Tzu, “Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.”

Jeff DeMaso:

Yeah, that’s a good one.

Josh Jurbala:

Yeah, yeah, no, it explains it well. And of course he’s talking about military strategy thousands of years ago, but it still applies to many aspects of life today, not just investing. Especially this year, you can think about it, 2020 just been wild and full of unexpected events that have thrown us all off track for long term plans we’ve had. Think of how easier it would have been if you’d had a plan already in place to deal with these unexpected events, like a pandemic. For instance, how to adjust your spending if you get laid off or the steps to take to protect your health. Even if governments and businesses had a more predetermined plan for dealing with the pandemic, I don’t know about you, but to me the whole first half of this year, the whole just felt on the organized, everyone’s flying blind and figured things out as they go along and that earlier wave, no one was prepared for this.

Josh Jurbala:

But I think it’s actually interesting to think about the later waves. Once local governments started introducing those phases and those metrics to decide when to lock down. People still complain, but it at least felt a little bit organized as if there was a plan in place and things were known in advance. Just a kind of good example of having tactics to deal with some kind of unknown, unexpected event.

Jeff DeMaso:

Josh, I think that’s a great example of why it makes sense to have a plan in place ahead of time before things get bumpy. But could you try and maybe before we get too far, if you’ll bring it back to investing too.

Josh Jurbala:

Let’s apply that concept to investing. The purpose of tactical strategies is to have that plan in place to keep you on track, especially during the periods of noise and uncertainty. And this is why we call them tactical strategies. We’re describing a method focused on shorter-term actions. I’m making more frequent moves, but the purpose is still to reach those long-term investment goals. Sometimes those goals are for more protection of your capital over shorter-term periods or holding riskier assets in your portfolio for greater growth or income needs. And that short-term plan might even be to hold for the long term and never to trade or it might be to rebalance your portfolio by trading once a quarter or that might include using a tactical strategy to manage those short-term actions and have that plan in place. Tactical strategies just help achieve those goals through a quantitative systematic approach.

Jeff DeMaso:

I think that’s great. And the way you talk about it reminds me of our financial plans, which go beyond just the investment strategy, but includes some other wealth management strategies. And we try and set those in place in the good times, knowing that there’ll be some bumpy patches ahead and how we’re going to get through them. But if I could pull on one thread there at the end, you said quantitative. I want to talk a bit about that. And I guess the question is really what does “quantitative” mean? But it’s in your title, investments quantitative manager, we talk about AIQ, Adviser Investments Quantitative, what do we mean? What are we saying there with the word quantitative?

Josh Jurbala:

Quantitative is one of those nebulous words. It can kind of refer to many things in many different contexts, but in the context of managing a portfolio, we consider quantitative strategies as having two main characteristics. The first, just being that it’s rules-based, systematic as I described it before. And then the second is that it’s based on quantitative analysis. Primarily using math and statistics to make those rules or decisions. That’s just in contrast to fundamental analysis, which uses more subjective research for investment decisions, such as judging the quality of the management team and the durability of its competitive advantage, but really often investors use a blend of those two approaches. Even fundamental managers and analysts will use quant methods to do their analysis, kind of think of P-E ratios and price targets, forecast of earnings growth. That’s all based on math and statistics.

Jeff DeMaso:

Absolutely. It actually makes me think of all the funnel graphs I see in every mutual fund pitch book, where they start with the universe of all the stocks out there and there’s no way you could possibly do fundamental analysis on all of them. How do they narrow that down? Well, they use a set of quantitative rules and screens to narrow their focus. And actually, to be honest, at Adviser Investments, when we’re looking at mutual funds, we’re blending the two as well. We’re looking at managers, we dig into their track record and run all the quantitative analysis on it. But then we also try to get to know the manager as well and understand their approach and their philosophy and the people behind it. Again, it’s kind of that blend that we use of quantitative and fundamental as well.

Josh Jurbala:

Yeah, no, that’s a great example. And the main difference between quantitative and fundamental is just that quant is more rules-based, as I said, and it’s often automated and algorithms and run using code. Won’t get into that here, but generally there’s just less subjectivity when making those decisions compared to fundamental investing. And so to that end, with our tactical strategies, we focus mostly on price for basing buy-sell decisions, which just removes the emotion from making those decisions. And that could be stock prices, index prices or usually we use ETF prices for example.

Jeff DeMaso:

Okay. I’ll bite there on “why price?” You mentioned removing emotion, but why else do you focus on price instead of the economic data or company earnings?

Josh Jurbala:

Good question. We focus on price for two main reasons. The first is that price contains so much information. Just think about what a stock price is based on. All prices are based on what market participants agree to buy or sell a stock at. Who are those market participants? They’re mostly individual investors, fund managers, traders and most of those, they’re fundamental investors making decisions. Think about how much information is just in that agreed to price that you see on the screen throughout the day. And for us, focusing on price minimizes the complexity of our strategies. We don’t concern ourselves with all the fundamental or economic factors that are underlying those prices. We will usually just think that it’s reflected in the price. And for tactical purposes, there’s just plenty of research that shows when you focus on price and measure the trend and momentum in stock prices, that’s the best way to make decisions and either make trades or get in and out of the market, especially when those prices are grouped into groups with common characteristics like sectors, regions and just broad markets.

Jeff DeMaso:

Okay. Before we get too far afield there, I want to ask you to define those two terms you mentioned, “trend” and “momentum.”

Josh Jurbala:

Yeah, sure. For our purposes, trend and momentum are based on the same idea that investments that have performed well recently will keep performing well in the future, at least over the short term. And likewise investments that have performed negatively or not performed well, will keep performing negatively or not perform well in the near future. And we can do a whole podcast on this, so we’ll save the deep dive for a later episode, but basically the idea of trend and momentum are just well-researched and they’re based on investor behavior. You’ve heard the term “madness of the crowd,” and just the idea that prices can deviate far from fundamentals, sometimes for long periods.

Josh Jurbala:

You only need to look at this year for examples of trend and momentum. We’ve talked all year about the stay-at-home trade with sectors like tech and communication being driven sky-high because our reliance on those companies increased during the pandemic. And those trends have persisted throughout this year. And so for the tactical strategies, the very basic idea here is to stay invested in those assets that are in a positive trend and sell the assets that are in a negative trend or stay out of them. And sometimes even our tactical strategies, we’ll trade to bonds or cash to manage risk when entire parts of the market are a negative.

Jeff DeMaso:

I’m glad you mentioned managing risk there because when you talk about madness of crowds and prices deviating from fundamentals, I start thinking, well, that sounds pretty risky. How do tactical portfolios manage risk? And the follow-up would be, how is it different compared to a well-diversified core allocation?

Josh Jurbala:

Another good question. And another topic we’ll dive real deep into in a later episode, but just to cover the basics here, it really comes down to what kind of risk you’re trying to manage. With tactical, we focus on limiting downside risk. Just reducing the risk of extreme loss to your portfolio. And why is that? It seems obvious, but extreme losses hurt more than the day-to-day ups and downs that we typically experience in the market. And that mainly has to do with the math behind gains and losses. If you have a $100 and lose 50% of that, you now have $50, but gaining back 50%, again, would only net you $75. To break even you have to gain back 100%, double your money. That just shows you the kind of what we would call asymmetric math behind gains and losses. Extreme losses hurt more.

Josh Jurbala:

And so for someone, especially who sells some or all of their investments near the bottom of that 50% loss, you need to gain back even more because you have less invested capital to help make up ground. That’s kind of the basics of what we’re going for. Luckily those 20 to 50% drawdowns in the market don’t happen often, but when they do, it can just be detrimental to your long-term success. And so that’s why with our tactical portfolios, we include cash or high-quality bonds as safer investment options and then actively trade to those to protect an investor’s capital during rough patches in the market.

Jeff DeMaso:

Yeah. I think the key words that you said were kind of the “actively trade” point. Because when I think about our core diversified portfolios, again, we know those rough patches happen. Bear markets unfortunately do happen. Fortunately, there are also bull markets more than make up for them, but it seems like to get through those rough patches, you’re almost relying on different things. With the well-diversified, more core portfolio, you’re relying on that diversification, which should provide a little bit of cushion, but really it’s that mindset of seeing through those short-term disruptions for that long-term gain. Where the tactical strategies, it sounds like you’re getting through those rough patches more through trading. Do I have that right?

Josh Jurbala:

Yeah, pretty much. Like you said, a diversified portfolio is good enough for most investors to hold in most market environments. And it’s definitely good enough to hold through those, like I said, the ups and downs, those kind of day-to-day moves, the fluctuations in the market. But even diversification can fail when rare sudden risks cause a major panic. Think back to March when the coronavirus unexpectedly hit and investors sold nearly everything near the bottom. Even U.S. treasuries and gold at one point, which are supposedly safe assets, were being sold in favor of cash. When true system wide panic sets in like a pandemic or the financial crisis in 2008, investors throw the baby out with the bath water and only cash seems safe.

Josh Jurbala:

That said, for those day-to-day fluctuations, we don’t need to be protecting every time our portfolio goes down 5% or even 10%. One of the central tenants of investing is you must take on risk to generate returns. I would even consider the day to day volatility kind of the good risk, the risk necessary to sit through and let your investment grow. But tactical strategies focus on managing what we would call “tail risk,” that just means the rare and unexpected extreme sell-offs and those can disrupt your long-term investing success.

Jeff DeMaso:

I think that’s a really interesting distinction between the type of drawdowns that we see. And your point about needing to take on some risk to generate returns is something we embrace at Adviser Investments. We often say that you should spend time in the market and we warn against market timing. I guess I’ll ask the question, is tactical investing market timing?

Josh Jurbala:

Yeah. That’s really the overarching question I hear all the time. The way I would simply put it is tactical’s a rules-based systematic approach compared to market timing, which is more based on emotion or gut feeling. We consider market timing as making major unplanned changes to your portfolio in reaction to major events or extreme market volatility. And that can just leave your portfolio far off your ideal allocation and be detrimental to your long-term goals, that strategy and those long-term goals we talked about. We just view tactical as a more reasonable, moderated plan in place ahead of time. And it’s just a better approach to adjusting your portfolio allocation gradually. And I think the other point I’d make is just that we consider it one strategy to include in your portfolio or investment plan and do not recommend it as a way to control your entire portfolio and all of your net worth. Even if tactical gets a decision wrong or underperforms, it shouldn’t be a major setback to your long-term performance because it’s only a piece of your entire portfolio.

Jeff DeMaso:

Josh, I think that’s a really important point you make there that not every tactical trade is necessarily going to work and what’s really key about it in my mind is that it is that disciplined way to both buy and sell. Because one of the things we talk a lot about is what makes market timing so difficult as you got to make two correct decisions: When to get out of the market and when to get back in. And when you’re just going by gut feel, it’s really hard to do both of those right. And so maybe tactical won’t perfectly time a top and a bottom, but you at least have the discipline that’s telling you when to get in and when to get back out.

Josh Jurbala:

Yeah, exactly. That’s the essential point. And I think, I really want to stress the fact that our strategies will gradually increase weight to those safer buffer assets based on kind of the defensive signals we spoke about. I think of it like gradually downshifting or tapping on the brake as you approach traffic on the highway, rather than having to slam on the brakes at the last minute. In the sense of investing, it’s all the people they actually, they’re, they’re fine for that first 10% drawdown. It’s not until 20%, 30%, 40% that they actually want to take out all their money out. Tactical is just more of a moderated approach to do that a bit ahead of time and gradually de-risk your portfolio. The way I like to sum it up is we view tactical as a way to extend your time in the market and your exposure to the market for investors who may not be comfortable or able to take on that market risk with a buy-and-hold strategic approach.

Jeff DeMaso:

Now Josh, I think that’s a great way to think about it as using tactical to extend your time in some of these risky parts of the market. Because when I think about time in the market, when we say that for me, it’s a mindset that there’s going to be difficult times in the market and you’re trying to see through those short-term rough patches to focus on the long term. But some people take it too far, to mean that we never trade, but we do. We trade in our core portfolios and we’ll have some tactical tilts in the portfolio. We might lean toward U.S. stocks versus foreign stocks, but they tend to be smaller shifts compared to what you’re doing in the tactical strategies. Let’s maybe talk a bit about who is this appropriate for? Which investors might want to think about tactical strategies?

Josh Jurbala:

Yeah, it’s another good question and another topic that we could really dive deep into, but I’m going to cover it real lightly here and we’ll go into it in another episode, but it basically comes down to behavior. The way I put it is, especially for defensive tactical strategies, which is what we’ve been focusing on here so far, those are mostly for investors with either a low capacity for risk or a low tolerance for risk. Retirees or investors withdrawing income have a low capacity for risk. And that just means they’re situationally withdrawing money.

Josh Jurbala:

Remembering that, in answering your last question, those people that have to withdraw money when there is a decline are the ones that are worst off because they have less capital invested to recover from that drawdown. And then on the other side of the coin is the people who have a low tolerance. They just withdraw money because they can’t handle the draw down because they just behaviorally can’t stand it. They have a low risk tolerance. That’s a just high-level kind of summary of the people that might go for a tactical strategy, at least in part of their portfolio to protect some of their assets.

Jeff DeMaso:

It makes a lot of sense when you put it that way, that depends how comfortable people are with risk and then what their situation will allow for. That said, I mentioned at the outset that I think tactical strategies are often misunderstood. And I often hear from investors that they actually have trouble sticking with them, despite the idea that tactical is supposed to help trade and smooth out some of those difficult times. I hear some frustration from some investors. Why do you think that is?

Josh Jurbala:

Yeah. The answer’s pretty straightforward. It’s mostly because tactical portfolios tend to underperform in the good times. When the market has those shallow five to 10% sell offs and then quickly recovers and resumes its long-term trend, that’s when tactical gets whipsawed, which is just a term we use when the strategy defensively moves to cash in reaction to those sell-offs or those sudden drops and then misses much of the upside before reinvesting. We kind of touched on this. And the market typically experiences those quick corrections more often than those rare extreme events that tactical’s actually made for.

Josh Jurbala:

Investors forget why they hold tactical and especially in decade-long bull markets, like we just had, they forget why they hold it and they grow tired of lagging because of those whipsaw periods. And then to make things worse, I always talk about these tactical strategies that are black box with complex rules; those can confuse investors. It makes the actual purpose of tactical confusing and it makes the act of trading difficult to stick with because investors don’t understand the moves that the portfolio is making.

Jeff DeMaso:

Okay. What’s the solution?

Josh Jurbala:

There are a few solutions and these are really important to understand how we at Adviser Investments approach tactical and try and differentiate ourselves from other tactical or quant firms that have those black box strategies. I guess I would break it into three parts to address those problems.

Josh Jurbala:

The first involves the strategy itself. Just how the strategy performs and behaves. It’s easier to stick with a strategy that’s easier to understand. What we do is we try and aim for simplicity over complexity. And that just means reducing unnecessary trading, sometimes holding maybe the broad market instead of going into specific sectors and regions when nothing else is trending, maybe just holding the default market is fine in that case. And then, that just makes it, like I said, less of a black box and people understand why the strategy is performing or trading the way it is. The other piece of that, it just involves the research process, knowing how the strategy works, making sure it’s reliable over different markets and market environments.

Josh Jurbala:

And then the second of the three parts, the three solutions, I guess I would talk about is suitability, just ensuring that these strategies are aligned to the right client or investor and then deciding where it fits in their portfolio. We touched on this earlier, having it as only a piece or a sleeve of your investment plan makes it easier to stick with when it’s not right in a certain case or not making the right trades.

Josh Jurbala:

And then that third piece involves communication, that third solution. And this is really key. It just means setting expectations, making sure clients or investors know that it’s not a holy grail. We’re not trying to beat the market and we’re just using it for tactical risk. We’re using tactical for risk management. We’re not trying to predict the market or forecast. We’re just trying to systematically manage risk.

Jeff DeMaso:

All right. That makes sense. Strategy, suitability and  communications are key. Let’s maybe pull on that last thread of communications and setting expectations. What’s the best way to explain this for someone who’s interested in tactical? How do we frame their expectations?

Josh Jurbala:

The way I like to put it is think of insurance. You hold insurance to guard against a rare extreme event. A house fire, a flood and then you pay a regular premium to protect yourself financially at least if your house burns down or floods. Sometimes that extreme event never occurs even in your entire life. Does that mean it wasn’t worth paying for the insurance? No, it just means that worst-case scenario didn’t happen, but it doesn’t mean it couldn’t have and it doesn’t mean it’s not worth preparing for or guarding against. We just encourage investors who use tactical to view it as portfolio insurance. And that premium is, that you will lag the market in really good times or during those kind of whipsaw periods when tactical wasn’t needed. But that doesn’t mean it might not fit your case or your situation to hold and be worth holding in a certain piece of your portfolio.

Jeff DeMaso:

Yeah. I think it’s really important that framing, because often when I talk to people and they are talking to me about their tactical strategy, they seem to have this idea that it is perfect. It gets them all the upside and none of the downside. That’s just unreasonable. As you said, it’s not a holy grail, there’s no strategy that works all the time in all environments.

Josh Jurbala:

Yeah, exactly. And we try and set that expectation ahead of time just so clients understand that. And we also try and limit that premium that I spoke about that you’re paying in the good times while still providing the protection during those rare, bad times. I would just sum it up as our goal is to make tactical practical and easier to hold over an entire market cycle.

Jeff DeMaso:

Make tactical practical. I like it, Josh. No, that’s great. Let’s stop here though. We’ve covered a ton of ground. To try and sum up a little bit, I think tactical investing as we practice it is disciplined rules based system to trading the market. And tactical is more about trying to take emotion out of investing and it’s about protecting your portfolio, making those scary times in the market more tolerable because you’re following a plan that you’ve put into place ahead of time. Josh, I don’t know, any other summary comments from you?

Josh Jurbala:

No, that was great. I think we’ve covered a lot. Obviously, it’s easy to dive deep in the weeds with this stuff, but I think we introduced some topics at a high level that we’ve laid some good groundwork to build on in future episodes so I look forward to it.

Jeff DeMaso:

Josh, I completely agree. We’ve got much, much more to discuss when it comes to tactical. Listeners out there, please be on the lookout for more podcasts in this series. This has been Jeff DeMaso and Josh Jurbala from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast.

Jeff DeMaso:

If you enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback really is always welcome and if you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. As always, I’d like to thank our editors Kailey Steele and Ashlyn Melvin and thank you for listening and happy holidays.

Podcast released on December 2, 2020. This podcast is for informational purposes only. It is not intended as financial, legal, tax or insurance advice even though these topics may be discussed. Information and events addressed in this podcast, as well as the job titles, job functions and employment of the podcast’s participants with respect to Adviser Investments, LLC may have changed since this podcast was released. For more information on each individual featured in this podcast, see the Our People section of our website.

The Adviser You Can Talk To Podcast is a trademark of Adviser Investments, LLC.

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When investors hear ‘tactical strategies,’ they hear ‘all of the upside, none of the downside.’ That is just not reasonable.


Jeff DeMaso, CFA

Director of Research

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