by Rob Bennett
I am often asked whether “Valuation-Informed Indexing is just new terminology for an investing strategy that has been around for a long time — Tactical Asset Allocation.
The answer is: “No.”
Tiger Legatus Master Fund was up 0.1% net for the second quarter, compared to the MSCI World Index's 7.9% return and the S&P 500's 8.5% gain. For the first half of the year, Tiger Legatus is up 9%, while the MSCI World Index has gained 13.3%, and the S&P has returned 15.3%. Q2 2021 hedge Read More
There are surface similarities. But the Valuation-Informed Indexing head is a very different head from the Tactical Asset Allocation head. The two strategies take you to very different places.
The similarity is that both VII and TAA call for occasional allocation shifts. The big difference is in the thought process that goes into the decision-making process as to when to make those shifts and what sorts of shifts to make. The allocation shifts made by Valuation-Informed Indexers are not optional shifts made with the hope of gaining some short-term edge. They are mandatory shifts. They are made solely with long-term considerations in mind. They are strategic shifts, not tactical shifts.
John Bogle is the primary advocate of Buy-and-Hold Investing. Bogle supports the idea of investors occasionally engaging in Tactical Asset Allocation. If you want to develop a clear understanding of why I say that the VII mindset is very different from the TAA mindset, I suggest that you read Bogle’s words in “support” of TAA.
Bogle supports the idea of investors making allocation shifts with obvious reluctance. He suggests that it would be better if investors didn’t make them while saying that there might occasionally be circumstances in which such shifts would not be such an entirely terrible idea.
Valuation-Informed Indexers celebrate the greatly enhanced returns and greatly diminished risks that come with making allocation shifts in response to big swings in valuations. We argue that it is a terrible mistake to fail to make allocation shifts when they are required for the investor to keep his risk profile roughly constant.
Bogle also fails to give clear guidance as to when the shifts are required. The sense you get when reading Bogle’s guidance on TAA is that it could be employed as a form of short-term timing. An investor might elect to lower his stock allocation because he had a feeling that stocks were priced high and would likely be headed downward in the next year or two.
This is precisely the sort of behavior that Valuation-Informed Indexers seek to avoid by coming to terms with the lessons of the historical data. We don’t trust our feelings as to whether stock prices are headed up or down in the short term, so we don’t turn to them for guidance on when or how to make allocation shifts. On the other hand, we do trust the 140 years of stock-return data showing that long-term timing always works. So we try hard not to give in to the feelings telling us that this might be the first time when sticking with a single stock allocation might work out in the long term.
We don’t think of allocation shifting as a guilty pleasure but as a responsibility to our rational selves. An election to fail to engage in allocation shifting when needed to maintain one’s risk profile is viewed by the Valuation-Informed Indexer as 100 percent emotional in nature. We view failures to engage in allocation shifting in response to big valuation swings as a capitulation to the Get Rich Quick impulse that has been ruining hopes for long-term investing success since the day the first stock market was opened for business.
The root difference is a difference in viewpoint as to whether there is any neutral stock allocation. The most frequently voiced objection to Valuation-Informed Indexing is that it is dangerous, that there is a chance that investors freed to make allocation shifts will thereby be freed to make poorly advised allocation shifts, that it is better to stick with a single stock allocation than to bring the rational thought process to bear on the question of what one’s stock allocation should be at any one particular time.
Valuation-Informed Indexers believe that we need to make greater use of the human capacity to reason in stock investing, not less. There is no neutral ground. There is no one stock allocation that is good enough to do the job at all possible valuation levels. To fail to take responsibility for one’s allocation choices by entertaining a fantasy that there is one allocation that might work well enough at all times is foolish and dangerous.
We certainly do not dispute that Valuation-Informed Indexers can make allocation choices that do not work out. But we dispute the idea that failing to take valuations into consideration could ever be a plus. We believe that the odds of our making good choices improve considerably when we open ourselves to consideration of the factor that has the greatest influence on whether a particular allocation percentage makes sense for investors in our circumstances or not.
Buy-and-Holders are robotic in their allocation choices. Valuation-Informed Indexers aim to be deliberate in their allocation choices. Those engaging in Tactical Asset Allocation play in a middle-ground between the two extremes.
They permit themselves allocation shifts. So they reject the robotic stance of the dogmatic Buy-and-Holder. But they do so apologetically rather than enthusiastically and thereby undermine their hopes of making shifts large enough to serve the purpose toward which allocation shifts should be aimed (to maintain a roughly stable risk profile in the face of price changes that make stock ownership far more risky at some times than at others).
Rob Bennett is a big fan of the Tightwad Gazette. His bio is here.