Tactical Asset Allocation: The Quest of Value

Maria Hartpence and Jacques Sikorav
Stuctured Asset Management, Crédit Commercial Français

Abstract

Today's investors have to address a whole range of issues, how to optimise the return on a portfolio of international equities or bonds; how to choose between stocks and fixed-income securities to build a diversified domestic portfolio; how to anticipate short-term fluctuations in the currency markets. In these times of easy access to the world's capital markets, the technique of tactical asset allocation, which involves making short-term bets that depend on market valuation, is now a vital part of the global management process. And one critical aspect of that process is the development of effective valuation tools.

This issue of ``Quants" presents the investment philosophy of CCF-SAM, the quantitative management subsidiary of Crédit Commercial de France, and the valuation tools the company has developed to cover the equity, bond and forex markets. The underlying purpose of all these models is to highlight long-run equilibrium prices and the forces working to push asset prices back towards the equilibrium level. The model's specifications take into account the globalisation of economies and financial flows as well as the special role played by the USA, Japan and Germany in the formation of prices in international markets.

In every market, the models point up fair prices that ensure a coherent global financial equilibrium. They reveal deviations between market prices and equilibrium prices -temporary differences subject to mean reversion forces that ensure averagely efficient markets-. However, these short-lived deviations also create arbitrage opportunities that can be exploited by tactical allocation. This is particularly true in the equity and bond markets, which are more predictable than the foreign exchanges.

The value added by tactical allocation is illustrated with examples of applications performed under diversified domestic or international management strategies.