Faced with volatility in all investment classes and threatening economic signals, tactical asset allocation managers have turned defensive, sharply reducing equity exposure in favor of bonds and cash.
TAA managers are the most reactive of investment managers. That most cut equities is significant, since they used widely different models and variables to arrive at the same conclusion.
"We have to be invested somewhere and, on a relative basis, the bond market is more attractive than what I would call a boring stock market," said Warren A. Johnson, president of Johnson Portfolio Group Inc., Boston.
"Mind you, I looked just last week at returns for intermediate Treasury bonds (with maturities between one and 10 years), and they've been experiencing their lowest returns in 25 years.
"But I think bonds are a good value and we're beginning to cautiously extend bond maturities to reap the reward in the next three months or so.
"In the short run, I think investors will be taking a lot of Alka-Seltzer to quell their queasy stomachs."
Johnson Portfolio Group has been completely out of equities in its typical TAA portfolios for several months, maintaining a 100% bond exposure, said Mr. Johnson.
While the company's model is unlikely to signal a move back into the equity market anytime soon, Mr. Johnson said he has been "encouraged by how well the stock market held its head up despite what's been happening in the bond market. It's not a terrible market and corrections are likely to be moderate if they happen. It's just not a very compelling scenario."
At Prime Asset Management Corp., New York, the firm's model has pushed it to an overweighting in bonds for the past several months, said Robert Groden, president.
Mr. Groden said a normal TAA portfolio managed by his firm would now be 70% bonds, 20% cash and 10% domestic equities. He said the firm decreased its cash allocation in favor of bonds few months ago. In July, the firm stood at 50% bonds, 40% cash and 10% domestic equities.
"If the interest rate trend continues, we're likely to move even further into cash, at the expense of bond weightings," said Mr. Groden. A move back into higher equity allocations would only happen if stock prices become more reasonable.
Renaissance Investment Management, Cincinnati, made a dramatic move to bonds during the first three quarters of the year. The company's three-way asset allocation portfolio contains 50% bonds, 50% equities and no cash. The firm had no money in bonds at the beginning of the year.
Renaissance also increased the bond weighting - to 40% from 25% at the beginning of the year - in its balanced portfolios. Its two-way asset allocation (equities and cash) moved to 80% equities from 100%.
The firm may step further back from the stock market, said Michael Schroer, director of research.
"We're seeing a 40% increase in bond yields since last October," said Mr. Schroer. "And that is really making the fixed-income markets more attractive relative to the stock market, where prices are flat."
Wells Fargo Nikko Investment Advisors, San Francisco, hasn't made changes to its so-called "normal" benchmark three-way asset allocation portfolios since March 16, but recent economic signals have triggered a move to increase bond weightings, said Larry Tint, managing director.
The three-way TAA model started the year with 70% stocks, 30% bonds; it moved to a 50% stock, 50% bond allocation early this year. Wells Fargo Nikko's model allows for 60 days before the trades have to be made once the signal has been given for a 10% shift in asset allocation. If a larger shift is needed, allocation changes are made immediately. Based on current information, the new equity exposure will be lowered to between 30% and 50%, Mr. Tint said, but added the signal could change before the trades actually are made.
Davis, Weaver & Mendel Inc., Atlanta, has a 100% cash weighting in both the firm's equity and bond asset allocation models.
"We don't spend our time in the middle, because you don't make money there," said Thomas Weaver, president.
The firm's equity model is very fluid, and has moved in and out of cash several times this year, with the latest move starting in late September and ending in early October.
Mr. Weaver said the model called for an all-cash allocation because of the poor breadth of stock market activity, with most of the volume of positive trading concentrated in a few stocks. Interest rate increases also moved the model to take a more defensive position in cash, said Mr. Weaver.
The bond model has been in a 100% cash position since mid-September, said Mr. Weaver, based on the trend of rising interest rates, the action of the Federal Reserve and declining bond prices.
The TCW Group Inc., Los Angeles, also reduced its domestic equity allocation in a so-called normal comprehensive asset allocation portfolio, but has substituted emerging market debt and alternative investments, rather than domestic fixed income.
Stefan D. Abrams, managing director for asset allocation, said: "We think the yield curve has a fair way to go, all along the duration curve, before we'll think to reinvest in domestic fixed income. I'm salivating right now over the mortgage-backed area, for instance, but the time just isn't right yet to get into that asset class."
TCW has rather more latitude than many firms to balance its typical asset allocation portfolios, because the model may invest in any of 43 investment classes.
The "normal" portfolio has a 40% domestic equity weighting, made up of 15% large-cap domestic equities, 10% small-cap growth equities, 10% mid-cap growth stocks and 5% very large-cap equities.
The remainder of the portfolio is composed of 30% emerging market equities, 10% emerging market debt and 20% alternative investments, such as investments in distressed company debt.
Avatar Associates Investment Counsel Inc., New York, started the year more heavily invested in equities, but hasn't moved much since making changes to its two-and three-way asset allocation portfolios at the end of the second quarter. The firm's two-way portfolio is 70% cash, 30% equities; the three-way, 45% cash, 25% equities and 30% low duration bonds.
"We're very cautious," said Francine Goldstein, managing director. "If the economy continues to move along too strongly, we're going to stay where we are. It will take a slowdown in the economy and an interest rate rally before we'll consider re-weighting our equity component."
