In February, we launched CMG AdvisorCentral with our white paper titled “Understanding Tactical Investment Strategies.” The paper was our endeavor to define tactical strategies in a constantly evolving industry. Financial innovation, while providing investors better ways to build portfolios, has created a need for education and the clear classification of strategies, benchmarks and peer groups.
The growth of the mutual fund industry and the increased participation of retail investors, in the 1980s in particular, drove a need to educate investors and to help them sort through the various mutual funds. The 80’s bull market for stocks and bonds drove investors’ demand for funds as well as their demand for information.
It was in this environment in 1984 that Joe Mansueto decided to start selling the Mutual Fund Sourcebook, Morningstar’s first product. The next year, the company debuted the Morningstar Rating for mutual funds. Fast forward 30 years, Morningstar has broadened its mission: it is now the largest provider of independent investment research in North America, Europe, Australia and Asia. Morningstar provides data on over 400,000 investment offerings, expanding well beyond the 400 mutual funds featured in the original sourcebook.
More importantly, since 1996, when the Morningstar Category classifications were created, they have become the primary classifier and arbitrator of investment strategies, benchmarks and peer groups. Along the way, Morningstar has built or acquired services to rate stocks, bonds, managed accounts, hedge funds and ETFs. Their company timeline serves as a chronicle for one of the most innovative periods in the history of finance. As with any new asset class or investment product, classifying tactical and alternative investments is an iterative process that continues to define more precise homogeneous pools of investments. Morningstar began creating a hedge fund database in 2004, and over the past 10 years, the convergence of hedge funds and mutual funds has brought alternative investments into the retail investors’ universe.
In 2008, the Alternative asset class was created as a catch-all for all alternative funds (namely those that did not fit into the other classifications) and has since been stratified to include 15 sub-categories, including managed futures and volatility trading, many of which were added in 2011. In late 2013, Morningstar added the first category classification that references “tactical” by adding the Tactical Allocation category for strategies that generate returns by materially shifting across equity regions and bond sectors on an active basis. Our Tactical Rotation Strategy is a perfect example of a strategy that falls within this category, shifting allocations across equities, bonds, REITS and commodities.
In our white paper we discuss the importance of momentum to tactical strategies and further delineate between various tactical strategies, breaking the category down to: trend following, relative strength, sector rotation, mean reversion and multi-factor strategies. Although Morningstar does not get this granular with respect to Tactical, it is likely that they are taking the same approach as with alternatives: start with a wide filter and then stratify over time. While our first white paper was an introduction to tactical investment strategies, our goal has always been to help define this new landscape for advisors who are looking to make meaningful comparisons between strategies in an attempt to enhance their clients’ portfolio construction.
As financial markets continue to develop, the need to educate investors and help them adopt new portfolio strategies has never been greater. Although Morningstar may be the final arbiter of how tactical is categorized, it is through the ongoing participation of investment managers, advisors and a range of institutions that will help shape the classification of these strategies and those yet to come. Although markets are constantly changing, we will remain a valuable, trusted resource during this evolution. – PJ Grzywacz