Tactical investing, also known as tactical asset allocation, appeals to many investors and advisors after decades of market turbulence.

These strategies typically track a quantitative model or trend-following strategy; the goal is to buy undervalued asset classes or market sectors while selling holdings deemed to be overpriced. For such plans, ETFs offer broad exposure to the underlying securities and timely trading.

“Advisors who are considering ETFs for tactical investing solutions probably have a shorter time frame,” says Michael Ball, a CFP and the president and lead portfolio manager at Weatherstone Capital Management in Denver. “As a result, it is probably better to stick with core indexes rather than try to use smart-beta ETFs.”

Smart-beta ETFs tilt their holdings in some manner in an attempt to outperform the broad market, but Ball cautions that it takes time for the factors in a smart-beta index to work.

Thus, tactical asset allocation timing may favor basic index ETFs.

“The most frequent goal of a tactical investment position is to provide increased exposure to a segment of the market for a short-to-intermediate period of time and then to reduce or eliminate that position,” Ball said.

“As a result, you want to use ETFs that have narrow spreads and good liquidity,” he said. “This can be particularly important if your reason for putting on a tactical position becomes invalid and you are readjusting your portfolio in a volatile market.”

PRACTICAL PROVIDERS

Advisors whose trades account for a significant portion of the typical daily trading volume of an ETF should consider using a “liquidity provider” to help minimize the potential market impact, Ball said.

“Firms such as WallachBeth Capital, Wolverine Execution Services and others may provide valuable services, potentially helping to improve the prices you receive,” he said.

Other ETF specialists might help advisors interested in tactical asset allocation.

“Our research indicated that equity index ETFs using a trend-following strategy based on the 200-day simple moving average can complement our other low-cost ETFs by giving our clients some downside volatility protection,” said Van Pearcy, an advisor with Raymond James Financial Services in Midland, Texas.

“Our investment committee visited with Pacer Financial and became very comfortable with using its Trendpilot ETF series, in addition to our long-only ETF positions,” he said. “As more ideas appear on the ETF landscape, we will keep our heads above the sand and research new ETFs for portfolio consideration.”

Tom Lydon, chief executive of Global Trends Investments in Irvine, Calif., offers some advice for advisors who are eyeing a trend-following approach.

“To keep out of trouble, maintain an 8% stop-loss on your ETFs,” he said.

“In addition, when an ETF declines below its 50-day average, that’s not a good sign. If that ETF falls below its 200-day average, sell it,” Lydon said.

Trend followers shouldn’t chase markets that are too hot, said Lydon, who is also the editor and publisher of ETF Trends.com.

“When world markets and industry groups collectively have hit new highs, the boom went bust,” he said. “Keep your emotions in check.”

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.

This story is part of a 30-30 series on smart ETF strategies.

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.