This article follows the concepts laid out in the previous article about Passive versus Active Management. The comments below give brief pro, con, and comments on the various strategies. With the benefit of hindsight, the market can seem predictable; however, many of these strategies are more useful in describing the market’s past than in anticipating its future.
Buy and Hold
Pro: Low cost as tries to avoid market timing and transaction expense. Assumes that asset prices always rise which is strongly supported by investment marketing. Much research showing that most indexes beat most active managers. Diversification is usually the justification. Generally it is tax efficient.
Con: Asset prices do not always go up and at times have significant losses. The investor must ride the bad times in order to be invested in the good times. Those times could come at a really bad time in the investor’s life. The investor must know what to allocate for diversification. The mere fact that there is no protection from bear markets resonates with most investors.
Comments: This is the simple solution for investors who want market returns but also understand they will also get market risks.
Strategic Asset Allocation
Pro: Can usually approach market-like return from diversification into market performance. It certainly sounds good.
Con: Similar to buy and hold in that no real protection from large downside moves in the market. The investor has to determine when and how often to rebalance the portfolio.
Comments: There is no proof that this process can outperform their benchmarks consistently. Why pay for this gamble of small excess performance
Dollar Cost Averaging
Pro: At least the investor is doing something by adding to fixed dollar amounts in down markets. Easy to set up with automatic contribution, plus it really sounds good
Con: Why buy more of something that is declining in value? Shouldn’t you be buying what is rising?
Comments: Sometimes the only way to work with some 401k plans. Fails miserably in secular bear markets and horrible to endure near retirement. Covered more thoroughly in this article: Dollar Cost Averaging.
Momentum
Pro: Always into the best performing assets. Usually a relative strength evaluation is used and then switching into the top group periodically.
Con: Difficulty sets in when to switch out of a holding to one that is outperforming. Must have rules to overcome this or trading costs can get large.
Comments: This is a good way to avoid the large bear markets, but it must be incorporated with rules to instill discipline in the process.
Sector Rotation
Pro: Usually always invested and often tied to a momentum selection strategy. When markets begin to become weak, can move into typically weak sectors such as utilities, healthcare, and staples.
Con: Usually always invested and that means the holdings, even though they are in perceived defensive positions, can get hurt in bear markets.
Comments: If cash were one of the asset classes this would be an improvement.
Alternatives* / Absolute Return
Pro: It has its day in the Sun. Diversification by philosophy might apply to many.
Con: Usually quite illiquid. Often can be viewed as black boxes.
Comments: Complex, plus an investor needs to know when to use and when not to use. Absolute return should be a goal, not an asset class or type of investment.
Tactical Asset Management
Pro: Often a rules-driven process that tactically moves into assets based upon their relative performance.
Con: Often is overly complex and can be done defensively or opportunistically. Can be expense and difficult to track with a benchmark. Rarely tax efficient. Whipsaws in non-trending markets can hurt momentum strategies.
Comments: Performance for most of these should be measured over the full market cycle; that is, from market top to market top, or from market trough to market trough.
*Alternative strategies can be further reduced to the following: Long/Short, Risk/Merger, Market Neutral, Convertible Arbitrage, Sector Focus, Event Driven, Real Estate, Managed Futures, Private Equity, and Venture Capital.
Dance with the Trend,
Greg Morris
