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Tactics for Wiser Investing  Thumbnail

Tactics for Wiser Investing

By: Jake Willms

Portfolio Analyst, The Milwaukee Company

As you may already know, The Milwaukee Company favors a systematic approach to portfolio management.   So exactly what is systematic asset allocation ("SAA")? 

Generally speaking, SAA involves adjusting the allocation of a portfolio's assets to take advantage of market opportunities and manage risk. This contrasts with a passive strategic asset allocation, which involves setting a long-term allocation of assets and sticking to it, regardless of market conditions.

Quantitative (QSAA) uses mathematical and statistical methods to analyze and model financial markets and securities. It entails the development of rules-based, academically sound algorithms that mathematically determine what portfolio adjustments need to be made and when to make them. The goal of QSAA is to optimize the portfolio's performance by dynamically adjusting the allocation of assets based on a range of factors, such as market conditions, economic indicators, and the performance of individual assets

Most SAA strategies lower exposure to riskier assets when economic and/or market data suggest trouble is lurking, and vice versa.  As a result, SAA creates the potential to generate higher returns, to lower risk, or both, than a comparable passively managed portfolio. 

Another benefit of QSAA is that because it is rules based, it limits the role emotions play when making investment decisions.  This is critical because as behavioral psychologists have repeatedly demonstrated, the innate behavioral biases we all share (including overconfidence, confirmation bias, and loss aversion, to name a few) can cause even the most seasoned and intelligent investors to make regrettable decisions.  (You can find a discussion of behavioral finance here). 

A third advantage to QSAA: because it is rules-based, strategies that utilize QSAA can be thoroughly tested and studied. That’s an advantage that’s not possible with many if not most qualitative strategies, which rely on unwritten rules executed by managers. As a result, the ability to examine how a QSAA strategy would have done in the past, and to use simulations to forecast how a QTAA strategy can be expected to perform in the future, can provide the confidence needed to stay the course when the stock market acts up.  

QSAA is not perfect, however.  One of its potential weaknesses is Its dependency on timely market and economic data. A delay or disruption in the receipt of such data can cause SAA strategies to generate below-market returns when the stock market changes course suddenly.  Sudden market reversals can cause SAA strategies to sell a security when the market is falling, only to buy it back again at a higher price after the market unexpectedly springs back.

No investment approach is perfect. For example, on occasion markets can move too quickly for SAA strategies to keep up. Therefore, it is important to carefully monitor the recommendations made by a QSAA model, and to be willing to deviate from those models when their recommendations seem inconsistent with rapidly changing circumstances.

In summation, QSAA provides disciplined, long-term investors with a logical, mathematically sound approach to investment success. When properly applied, it can provide investors and their advisors with an informed and disciplined approach for making asset allocation decisions.