Unlike passive investing, which involves setting allocations to indices and letting them ride, tactical managers strive to outperform their stated benchmarks by seeking opportunities in the markets and/or managing risk exposures during negative market cycles.
The key difference between a tactical approach and passive investing is the issue of “alpha.”
“Alpha gauges the performance of an investment versus the market's movement as a whole. The excess return of an investment relative to the return of a benchmark is the investment's alpha.”
Passive investors make no effort whatsoever to add alpha to their portfolios. Much like a sailboat, buy-and-holders simply set their portfolio allocation sails and let the market winds carry the portfolio where they may.
On the other hand, tactical investors don’t just accept what the market provides, they actively manage their portfolios and adapt to changing environments. In short, a tactical manager seeks to create alpha and to manage risk, while passive investors do neither.
The next logical question is, how do tactical managers generate alpha?
TFA believes there are three ways to produce alpha.
- Timing
- Selection
- Leverage
Put simply, Timing is “when” you buy and sell, Selection is “what” you buy and sell, and Leverage is “how much” you buy and sell. These three portfolio “levers” allow tactical managers the opportunity to outperform the buy-and-hold approach.
