The RIA Guide For Mastering Fixed Income Tactical Asset Allocations

The RIA Guide For Mastering Fixed Income Tactical Asset Allocations

Tactical asset allocation (TAA) is an active management portfolio strategy that rebalances the proportions of assets to capitalize on market pricing anomalies or exceptional performance from some market segments. This strategy allows portfolio managers to create extra value by leveraging favorable short-term market conditions. TAA provides the flexibility most static strategies lack, making it a popular choice for savvy RIAs and IARs to use for their clients.

The role of fixed income in TAA is crucial. Fixed-income securities, primarily bonds, provide steady income streams and are less volatile than stocks, making them an excellent form of diversification. 

However, fixed income isn’t merely used for stability and income in a tactical asset allocation strategy. It’s a fluid part of a larger puzzle, used to adjust to current market conditions and take advantage of potential short-term market movements representing significant investment opportunities.

Today we’ll be discussing the following:

  • Understanding the Role of Fixed-Income in Tactical Asset Allocation
  • OCIO Strategies for Fixed-Income Tactical Allocations
  • Why more RIAs and IARs are using OCIOs for Investment Research and Portfolio Management Services

Understanding the Role of Fixed-Income in Tactical Asset Allocation

The cornerstone of a successful investment strategy lies in the understanding and application of asset allocation. This can encompass dividing a balanced investment portfolio into asset classes that include equities, fixed income, and alternatives. 

TAA is the dynamic strategy that adjusts the asset mix based on financial markets and economic trends. In this case, one of the core asset classes in TAA is fixed income.

Fixed-income securities, including bonds, bond funds, and bond ETFs, provide a steady income stream for investors, essentially “fixing” a portion of their return with a higher income stream than stocks. This is a crucial feature for investors looking for relative safety and stability, especially during volatile or bear markets.

Tactical asset allocation employs this strategy of investing in fixed income by temporarily increasing its allocations to bonds before market downturns. For instance, when equity markets perform poorly, fixed-income securities can act as cushions by reducing losses and providing higher income returns. This aspect of the TAA strategy can maintain liquidity and reduce the downside risk of an investment portfolio.

Certain fixed-income securities may also effectively hedge against inflation when the OCIO uses inflation-protected securities (TIPS). Thus, TAA can be a way to utilize fixed-income securities to protect purchasing power and produce real rates of return for investors.

That said, it’s important to remember that fixed income isn’t devoid of risks. Interest rate, credit, and inflation risks can impact the value of fixed-income investments. These must be carefully researched when utilizing TAA.

OCIO Techniques for Fixed-Income Tactical Allocation

An Outsourced Chief Investment Officer (OCIO) can employ several strategies for tactical allocation in the fixed-income sector:

  1. Interest Rate Anticipation: The OCIO can adjust the portfolio based on expectations of interest rate movements. If rates are expected to rise, they may shorten the portfolio’s duration to reduce interest rate risk. Conversely, if rates are expected to decline, the OCIO could increase the portfolio’s duration to capitalize on bond price increases.
  2. Credit Analysis: This involves examining the creditworthiness of bond issuers to assess default risk. The OCIO can lower the portfolio’s risk profile by favoring higher-quality issuers. Conversely, if the OCIO is willing to take on more risk in exchange for higher potential returns, it might allocate more to high-yield bonds.
  3. Sector Rotation: Different sectors of the bond market (e.g., Treasuries, corporate bonds, municipal bonds) perform differently under various economic conditions. The OCIO can overweight or underweight specific sectors based on macroeconomic forecasts and relative value analysis.
  4. Yield Curve Strategies: The OCIO can change the portfolio’s exposure to different maturity segments based on expectations of changes in the shape of the yield curve. For example, the OCIO might execute a “barbell strategy” (investing in short-term and long-term bonds) if they expect the yield curve to steepen.
  5. Currency Management: For global fixed-income portfolios, managing currency risk is crucial. The OCIO might hedge foreign currency exposure or take on additional exposure if it has a strong view of currency movements.
  6. Active vs. Passive Management: The OCIO must decide to what extent it will actively manage the fixed-income allocation. Active management might involve all the above strategies, while passive management might duplicate the holdings of a fixed-income index.

In all these strategies, the key is balancing risk and reward to achieve the investment objectives while staying within the client’s risk parameters.

Why more RIAs and IARs are using OCIOs for Their Investment Research and Portfolio Management Capabilities

The role of an Outsourced Chief Investment Officer (OCIO) has been gaining popularity among Registered Investment Advisors (RIAs) and Investment Advisor Representatives (IARs). This is because OCIOs bring the expertise and resources that many investment firms need to grow and retain clients simultaneously. They can provide comprehensive investment management services, including investment research, strategy development, and day-to-day portfolio management.

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With the increasing complexity of financial markets, the vast array of investment options, and the continual need for timely data and insights, many RIAs and IARs find it challenging to manage all these aspects in-house. 

An OCIO provides an effective solution, allowing the investment firm to focus on its core capabilities and client relationships. At the same time, the OCIO handles the intricacies of investment research and portfolio management.

An OCIO’s expertise in tactical asset allocation can be particularly valuable. An experienced OCIO can provide informed insights about current market conditions, identify opportunities for tactical allocations, and execute those changes quickly and efficiently. 

With an OCIO’s help, an investment firm can more effectively implement a tactical asset allocation strategy, including using fixed income, to enhance client returns.

The Cornerstone Difference  

The way we provide outsourced CIO services is uniquely different from other firms:

  • We are designed to blend effortlessly into your daily operations without necessitating any changes to your workflows or systems. 
  • We’ll maximize your existing tools, including CRM, custodial software, client reports, and portfolio management applications. 
  • We offer our presence in selected client and prospect meetings to bolster your capacity to forge new relationships and strengthen existing ones. 
  • Our white-labeled investment research and management process ensures seamless integration. 
  • We uphold your brand image to prevent any potential client confusion. 
  • There’s no need to change custodians, initiate new client documentation, or cause significant disruptions to your clients’ existing portfolios.
  • You can rest assured that our suggestions are made with a keen sensitivity to tax implications and are meticulously aligned with your unique investment philosophy and process.

Let’s discuss if your firm can delegate part or all of your investment research, portfolio management, and monitoring to an OCIO. Contact the Cornerstone team for more information

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More about the author: Thomas Balis

Thomas holds a Bachelor of Science in Business from Ohio State and has since earned the Chartered Financial Analyst® (CFA®) designation as well as the Accredited Portfolio Management Advisor (APMA®) and Chartered Mutual Fund Counselor (CMFC®) certifications.