I spend way too much time thinking about tactical asset allocation (TAA).
I estimate we have tested around a 1000 perturbations of TAA models (maybe more).
Some models work well, others not so well.
After torturing the data like no other, a lightbulb went off in my head…
What if tactical asset allocation is all hocus pocus???
A nice question, but how would one assess this statement?
I built a simulation model that incorporates a random tactical asset allocation rule. How does this rule work?
- If a random number generator (0=<x=<1) is less than .33333, invest in t-bills,
- Otherwise, stay in the SP 500 Index (Total Return)
So easy homer can do it:
Here are the baseline stats on the Buy and Hold (B&H) SP 500 Total Return Index and the T-Bill from 1/1/1927 through 12/31/2012:
Here are the results from a 1000 “Random Tactical Asset Allocation” models:
- Random tactical asset allocation models have a higher Sharpe than B&H 15% of the time. Sharpe ratios above .3 occur 4% of the time.
- Max drawdowns are lower 95% of the time. However, cutting MaxDD below 60% only happens 12% of the time.
- CAGRs are higher 4% of the time and never exceed 12% CAGR.
Be wary of tactical asset allocation model salesman pitching higher Sharpes, lower maximum drawdowns, and similar CAGRs.
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