Tactical Asset Allocation vs. Passive Indexing

The recent movement in rates has partly upended various investment approaches in the Fixed Income world. The decades-long bull market had led portfolio managers to expect a good portion of total return from being indexed to long duration benchmarks. Momentum models based on historical returns were biased by taking data points from a falling rate environment. The challenge going forward is how to adjust the investment management process of a Fixed Income portfolio in a potentially rising rate environment with dynamic shifts in the shape of the yield curve.

We believe Fixed Income strategies should continue to be part of a long-term portfolio but with a greater emphasis on tactical sector allocation. Passive indexing exposes investors to significant duration risk relative to current yield levels offered in the generic government and Investment Grade sectors. One of the primary goals going forward should be to manage sector exposures dynamically and tactically without making risky macro calls. A Multifactor modeling approach offers an attractive solution that can produce additional price gains to supplement income generated from Fixed Income portfolios. This type of approach will also opportunistically adjust duration exposure at the appropriate time to take advantage of higher yields at the longer end of the curve.

Certain fixed income sectors still provide respectable income levels with some potential price appreciation. These opportunities should be considered in the context of these sectors’ individual risk levels and correlation benefits in a diversified portfolio, as we discussed in our January 2021 commentary. Floating rate instruments will provide rising rates protection, but the impact of longer spread duration risk should be accounted for as well. Adding TIPs (“Treasury Inflation Protected Securities”) for inflation protection may not provide the desired effect. How much inflation is priced into the TIPs market vis-à-vis current CPI expectations? Are investors comfortable with the underlying rate duration exposure in longer maturity TIPs? These types of fundamental questions need to be addressed before their inclusion in a portfolio.

Liquidity is another major factor that needs to be considered in creating a dynamic Fixed Income portfolio. Trading individual cusp bonds can often be challenging, especially in a volatile market environment. Sector ETFs have gained popularity and offer significant liquidity, even in stressed market environments. By properly utilizing the right mix of ETFs, sector rebalancing is greatly facilitated with minimal transaction costs.

FolioBeyond’s model-based tactical approach offers an attractive solution for a meaningful portion of a Fixed Income portfolio. Its multifactor model captures relative value relationships and risk differentials to provide optimized portfolio allocations using a subset of 23 liquid sector ETFs. Its algorithmic approach seeks to be at the efficient frontier of the Fixed Income market with proper risk constraints incorporated into the optimization. This process has a high likelihood of generating attractive sector allocation alpha to supplement the current environment’s lower yield levels. The good news is that volatility creates opportunities, and a systematic approach should be able to capture these inefficiencies in a timely manner.

Please contact us to explore how our optimized portfolio solutions can help you manage your overall fixed income portfolio in the current environment.

James Viceconte 

Chief Marketing Officer

Co-Chief Investment Officer

(W) 212-299-5526

C) 203-249-6661


Yung Lim

Chief Executive Officer

Co-Chief Investment Officer


(W) 212-397-7539

 (C) 917-892-9075

Other posts

NDR Dynamic Allocation Strategy July 2023 Update

Dynamic Allocation Strategy, indicators, weightings update Read more →

NDR Fixed Income Allocation Strategy April 2023 Update

The NDR Fixed Income Allocation Strategy, Positioning Update Read more →

NDR Fixed Income Allocation Strategy February 2023 Update

The NDR Fixed Income Allocation Strategy, Positioning Update Read more →
Back to all posts →