Getting the tactics right

Immediately after the catastrophic 9.0-magnitude earthquake struck Japan on 11 March, Westerners in the country scrambled aboard chartered flights to escape the nightmare. It is easy to understand why they fled the tragedy, whose death toll is expected to reach 2,500 and which triggered a series of disasters, including a nuclear leak now upgraded to the same potential level as Chernobyl.

However, in the midst of the aftermath a small group of Europeans did the exact opposite and boarded aeroplanes heading straight to the disaster zone. Unpalatable as it may sound, they were wealthy individuals who, having seen Japanese share prices plummet as a result of panic selling – on Monday 14 March the Tokyo Stock Exchange saw 23,500bn yen (€200bn) wiped from its value – spotted an opportunity. “I know some investors that headed directly to Japan to investigate opportunities on the ground,” says Olivier Zucker, founder and managing director of private client consultant Zucker & Co Investment Advisors. “Many people have seen an opportunity to get exposure to Japan.”

Welcome to the world of tactical investing, where lightning-fast reactions to unexpected market events aim to capture value immediately an opportunity flashes up.

Tactical investments, which are relatively fleeting, lasting from between three to six weeks to up to three months, have huge potential to bring short-term profits. Indeed, to take the Japanese example, by 16 March the Tokyo stock market had rebounded. In the current market conditions, with unforeseen events like the turmoil in the Middle East and North Africa fuelling market volatility, it is clear why such tactics are on the rise. So is now the time to abandon long-term strategic investing in favour of shorter-term tactics?

Tactical moves

The recent string of unanticipated market events certainly adds weight to the argument for tactical investments. Consider the macro economic picture. We have rising oil prices sparked by uncertainty in the Middle East and North Africa, overheating emerging markets, currency instability – particularly in the case of the euro – combined with rising inflation and interest rates, including, for example, the European Central Bank’s surprise 0.25 per cent rate hike on 7 April. In this climate it is arguably more difficult to be sure of the results of a long-term investment strategy.

Nicolas de Skowronski, head of investment advisory at Julius Baer in Switzerland, says a tactical approach is necessary at times. “Our recent reallocation of some equity exposure from emerging Asia towards Russia was a tactically influenced reaction to the unrest in Northern Africa driving up energy prices,” he says. “Russia for us is a clear ‘oil play’ and likely to remain so as long as the energy prices maintain their upward pressure.”

Similarly, whilst Julius Baer believes Latin America has strong momentum long-term, it recently took some value out of its investments in the region as it has identified a higher risk of inflation. “We believe the probability of rising inflation has increased to 25 percent and we have adjusted our global portfolio accordingly, adding 3 percent of equities in developed markets for fixed income investments,” says Mr de Skowronski. “Also we have increased our exposure to commodities, apart from gold, as a further hedge against inflation.”

Burkhard Varnholt, chief investment officer at Swiss-based Sarasin, says tactics are essential in today’s financial markets. “We are seeing profound changes in the world, from technological developments we could never have imagined to huge population growth.” The global population grew from 1bn to 7bn in the last century and we are rapidly heading for 9bn, he says. “The nature of the global village we live in means society is much more interlinked and complicated than ever before, so there are more dependencies and correlations in the markets.”

This all means that “small events will have global consequences”, whether for better or worse, and we will continue to see volatility and unexpected market events, according to Mr Varnholt. “As a result there will be opportunities every time something happens and investors will have to judge the situation and place their bets accordingly.”

Strategic decisions

Others are more wary of tactical approaches, though. Mr Zucker, for example, is in favour of investors holding their nerve. “The volatility of the last few months is nothing compared to 2008 or 2002. There is a lot of uncertainty in the system right now but I don’t think we are at the tipping point that would justify short-term reactions.”

He adds that portfolios should be better set up to deal with volatility these days. “Many fund managers have learned lessons in the past few years, which meant that they were not foolish ahead of the current crisis and they were therefore less exposed.”

Mr Zucker doubts, for instance, the significance for the markets of the uprisings in the Middle East and North Africa. “People did not have significant exposure to this region, although the oil price is important of course.” But he adds that even rising oil prices should be taken with a pinch of salt: the price of oil had risen to around $70 (€49) to $80 a barrel in the 18 months preceding the political upheaval we are now seeing, he says, and the last rise we saw, fuelled by the turmoil, was to $95.

“But this does not seem to be having a great impact on the world economy for the time being, apart from a degree of falling consumer confidence due to the higher cost of filling your petrol tank. So it would be premature to rebalance portfolios due to the oil price hike.”

Serge Lederman, head of asset management and group managing director, Banque Heritage, warns that the danger of tactical moves is that they may run counter to your fundamental investment principles. “The picture is far from clear and certain at the moment and there are a lot of events making headlines that are driving emotional responses,” he says. “But with an investment hat on you have to look at the world differently.”

This may mean reassessing your instinctive response to a dramatic event like the Japanese earthquake. “Japan is a large economy and what we are seeing in terms of disruption is actually not that significant when it is put into perspective.” Instead of thinking about short-term share price volatility, Mr Lederman believes the most significant factor about events in Japan was the central bank’s response.

“The fact that the bank immediately pumped liquidity into the system meant markets recovered quickly after the initial shock. As a result you can keep more of an exposure to riskier assets in Japan than you would otherwise because Japanese financial assets will be supported by the significant liquidity pumped into the banking system – a kind of Japanese ‘quantitative easing’.”

With this being just one of instance of the increasingly pivotal role central banks are taking around the globe, Mr Lederman says asset allocators must – at a strategic level – account for this. “In 2008 we entered a new era in terms of what central banks can do for markets and they are playing an increasingly powerful role in creating liquidity, which is very supportive for investments.”

The new attitude of central banks may come with a price, however, which is that one day they will take the liquidity back – with some commentators arguing that they are currently merely “kicking the can down the road” – and this may cause rising interest rates, as we are already beginning to see in emerging markets and more recently in Europe. But Mr Lederman says this must be tackled not with tactical moves but by planning ahead, strategically. “We must prepare for higher interest rates going forward but the basic principles of investment remain the same as they have been for at least 70 years; we are not entering a new paradigm.”

Michael O’Sullivan, head of UK research and global portfolio analysis for Credit Suisse’s private banking business, agrees that despite the seismic shifts in the macro economic situation, investment principles should remain intact. “Are the events we are seeing now big game changers? Well, we are devoting a lot of resource to researching this and we are ready to adjust our asset allocation accordingly when events come along and necessitate it. But is now the time for tactical moves? No, we rather maintain a strategic approach. Indeed, the trends we are seeing are long term anyway.”

In line with this, Credit Suisse did not increase its exposure to Japan in the wake of the disaster. “We are neutral on Japan,” says Mr O’Sullivan. “We like some of the export stocks, like Toyota, but we resisted the temptation to jump in and overweight equities because we don’t yet see the factors that would catalyse the value.”

Instead, the bank has stuck to its overriding strategy of a bias to equities over bonds. It uses classic strategic techniques, such as counterbalancing an overweighting in the energy sector for the past several months with being neutral on emerging markets, where stocks are very sensitive to the oil price.

Mixing the two

However, both Mr O’Sullivan and Sarasin’s Mr Varnholt say that for certain clients, particularly those less risk averse, they offer a tactical overlay. There seems to be a degree of consensus around this approach. “Some of the macro economic developments happening now are fundamental and should lead to strategic changes, whilst some are not,” says Mr de Skowronski at Julius Baer. He says the two factors can be tackled with a “strategic approach with a tactical bias”.

In this way, Julius Baer is using both strategy and tactics to deal with Japan. “The events in Japan were unexpected and will have an impact on the performance of the average portfolio, so you need to take a tactical view on Japan, hence our rebalancing towards Russia.” However, the bank had an investment in Japan before the earthquake and whilst it has been affected by short-term volatility, Julius Baer has kept its exposure because it still believes the case for Japan is valid. Indeed, the weaker Yen will likely support the country’s exporters.

Mr de Skowronski sums up: “At a strategic level, the bank still believes in the long-term growth story of Asia but we want to be able to play tactically too.”

This seems a reasonable approach to the plethora of macro economic events we have seen in recent months: Cautiously sticking to an underlying, long-term, strategy whilst leaving scope for tactical plays to take advantage of surprise opportunities.

Don’t follow the herd

Talisman Global Asset Management recently switched from being a single to multiple family office and manages 70 per cent of its assets in-house. Talisiman’s portfolio is currently slightly underweight equities against its internal benchmark and overweight emerging market equities and credit, especially high-yielding local currency bonds in Turkey and Brazil. “Tactical investing is fashionable at the moment because the recent series of unexpected events has made people feel they can’t get a grip on what the future holds,” says Julian Sinclair, chief investment officer at Talisman. “But investors should take a position that is different from that of the herd.

“To take emerging markets like the Middle East, as long-term investors it is not about quickly trading in and out, instead we have to think about three main things: inflation forecasts, how sovereign debt is going to be repaid and how much growth is priced in to securities. Everything else is just noise,” says Mr Sinclair.

Many of the funds investors would have thought could take advantage of tactical approaches, such as long-short equity vehicles, have not performed well in recent months. A great deal of money has been wasted by trading frequently, he suspects.

“I believe the environment is probably too volatile for all but a handful of the best traders in the world to succeed with a tactical strategy. Just look at the FTSE over the past six months. If you had approached it tactically, every time you increased exposure in one area you would have been right for about two weeks and then wrong – and in the meantime you would probably have missed some major opportunities.”

Putting tactics into action

When are tactical approaches suitable?

A decision to invest tactically should, as ever, be governed by the investor’s capacity for risk. Kevin Lecocq, head of global investment solutions at Deutsche Bank Private Wealth Management, cites the example of recent events in Japan and the Middle East and North Africa. He says that when markets went down in March, clients with a long term view and a capacity for volatility bought in the dip, just as deep value investors like Warren Buffett tend to do. Other clients, he says, “took the view that we have nuclear issues in Japan and the risk of revolution in Saudi Arabia, so lets cut our investments here As it turned out, markets lifted and these clients missed opportunities – but it was right to get out of those markets because they could not afford to lose 15 or 20 per cent.”

Ultimately, it boils down to the length of the investment horizon. William De Vijlder, chief investment officer at BNP Paribas Investment Partners says: “In the long term, say, five years and beyond, strategic asset allocation still makes sense but for a six-month term, the themes driving the market are changing swiftly so investors have to be increasing diligent in chasing opportunities.”

Which products are best suited to tactical investing?

With more investment products on the market in Europe than actual securities, choosing products has never been more bewildering. But most investors agree the best products for shorter term tactical investments are Exchange Traded Funds. Nicolas de Skowronski, head of investment advisory at Julius Baer, says: “You can enter and exit an ETF fast so they’re idea for active, advisory clients.” He also recommends structured products to get benefits from spikes in volatility and enhanced indices and mutual funds to “avoid the pitfalls of direct investment in shares”.

What role can alternative investments play in tactics?

Alternatives, particularly hedge funds and private equity, can provide useful diversification to counteract the risk of tactical plays. Whist clients may be wary after the hedge fund issues seen in recent years, Mr de Skowronski tackles this by opting for funds of hedge funds, which carry less risk and offer greater liquidity.

Michael O’Sullivan, head of UK research and global portfolio analysis for Credit Suisse's private banking business, adds: "The performance of hedge funds over the past year has been strong. There has been a real sorting out in terms of quality"

How much client demand is there for tactical plays?

Levels of enthusiasm for tactical approaches vary between clients but there is evidence of growing interest in discretionary mandates, which facilitate the fast decisions required for putting tactics into action. Whilst 2008 saw many discretionary portfolios deep under water, prompting clients to return to the perceived safer ground of advisory, this is beginning to change. Mr De Skowronski says: “Clients increasingly want the benefits of combining solutions to fit their needs.”