TREND AGGREGATION: An Advanced Approach to Tactical …

TREND AGGREGATION:

An Advanced Approach to Tactical Asset Allocation

Tuttle Tactical Management

Tactical Asset Allocation (TAA) is becoming more popular as investors prefer a methodology that can protect from market downside while still participating in market upside. Unfortunately, most tactical methodologies fail to protect investors in all markets. Trend Aggregation, a dynamic tactical approach that adapts to changing markets, helps in solving this issue.

Traditional tactical management styles do well in a straight up or straight down market, but tend to struggle to perform well in choppy markets. Trend Aggregation differentiates from a traditional tactical style by having well-defined strategies for all market climates.

Trend Aggregation

Trend Aggregation is a multi-dimensional strategy that can adapt to and perform well in all types of market environments. This involves combining methodologies that have different uncorrelated return streams, such as intermediate-term momentum methodologies and short-term countertrend methodologies.

As a result, Trend Aggregation methodologies can protect against large losses during market downturns, while still positioning investors for gains when the market is trending upward. This management style analyzes trends and countertrends, positioning investments according to confirmed information from the markets. The Trend Aggregation approach includes a strategy not only for markets with a clearly defined trend, but also for choppy, directionless markets.

This management style concentrates on several factors when striving to generate strong returns, including:

1. Staying heavily weighted in stocks when stock momentum is positive.

Momentum is the tendency of investments to persist in their performance. In other words, sectors that outperform during a given time period tend to continue to outperform.

Momentum analysis should be used to determine the best way to allocate among stocks and bonds and then to decide which stock and/or bond sectors to include being in the strongest market cap sector amid large-cap, mid-cap and small-cap stocks. For the stock portion of our models, Trend Aggregation does not look for exposure to all asset classes. Instead, confirmed trends identify the strongest sector for positioning investments.

2. Using countertrend analysis to buy into short-term lows and sell into short-term highs for stocks.

Countertrend analysis looks for signals to buy when markets are oversold and sell when they are overbought. This type of analysis takes advantage of the fact that over the short term markets are dominated by noise, fear, and greed. This causes the market to overshoot on the upside and downside before eventually snapping back to equilibrium. Countertrend trades are typically much shorter in duration than momentum trades.

Trend Aggregation hedges market risk by moving out of stocks during difficult markets. If bonds are attractive, the move is there. When bonds are not attractive, the move is to cash.

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Trend Aggregation vs. Traditional Tactical Asset Allocation

As mentioned earlier, traditional tactical management styles do well in straight up or straight down markets, but tend to struggle to perform well in choppy markets. Trend Aggregation tends to do well in all markets.

Traditional tactical asset allocation may protect from losses due to a specific methodology, but any one methodology can go in and out of favor. A momentum methodology, for example, relies on whatever asset class happens to be strong, remaining strong for a long enough period to profit. During choppy market environments, market leadership will often vary from month to month with no discernible trend to latch onto.

There are typically three types of markets:

? Markets that go up in a fairly straight line

? Markets that go down in a fairly straight line

? Choppy markets that could go in either direction

In a traditional asset allocation framework, the investor treats each market the same. He rides the bull market up, he rides the bear market down, and he moves up and down with the choppy market, hoping for a positive result.

In a traditional tactical approach, an investor participates in most of the returns of a Bull Market and avoids most of the downside of a Bear Market. However, choppy markets present a problem as there is no defined trend for the tactical investor to follow.

When using a Trend Aggregation approach, each type of market is handled differently. In Bull Markets, investors are mostly or completely in stocks. In Bear Markets, investors are completely out of stocks, but have the ability to participate in bear market rallies through countertrend methodologies. In choppy markets, investors use a countertrend approach to make money from market overreactions.

Actual vs. Perceived Diversification

Traditional tactical asset management diversifies portfolios through different asset classes, which is referred to as perceived diversification. Trend Aggregation uses actual diversification by combining noncorrelated methodologies or return streams.

Traditional asset allocation, which uses perceived diversification, attempts to achieve diversification by having different asset classes, i.e. large stocks, small stocks, international stocks, etc. These assets might appear to be somewhat undiversified when looked at over different time horizons, but their returns come from the same metric, rising stock prices, while their risks come from the same metric as well, falling stock prices. Therefore, a drawdown in one asset class is usually accompanied by a drawdown in the others as investors indiscriminately sell equities during market downturns.

Actual diversification, which is used by Trend Aggregation, is accomplished by diversifying through multiple tactical methodologies, time frame variation, market basket variations and underwater correlation analysis.

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Underwater Correlation vs. Standard Straight Line Correlation

Trend Aggregation uses underwater correlation analysis to combine uncorrelated methodologies with different return streams. Underwater correlation looks at how methodologies are correlated during downturns. For example, a momentum methodology will buy an asset when it is high and sell it when it starts to weaken. A countertrend methodology will buy an asset when it is weak and sell it when it starts to strengthen. You could apply each methodology to the same investment and get a completely different return stream.

Traditional straight line correlation takes a series of returns for two or more asset classes or methodologies to determine whether the return series is correlated. This type of analysis only establishes whether the asset classes or methodologies were correlated over a chosen time period. Straight line correlation doesn't answer the most important question, as well as the reason for diversification, which is when one asset class or methodology is in a drawdown, how is the other one performing?

Summary

Trend Aggregation management style offers the ability to profit during market uptrends, while avoiding large losses during sustained market declines. It can increase the potential of tactical asset allocation by employing additional diversification techniques. These techniques include diversification through time frames and management styles, not simply diversifying asset classes.

Matthew Tuttle, CFP?

Tuttle Tactical Management (TTM) takes an active approach to money management and is the industry leader in Trend Aggregation. TTM utilizes proprietary methodologies for its Trend Aggregation strategies.

Certified Financial Planner? Board of Standards, Inc. owns the certification marks CFP?, Certified Financial Planner? and federally registered CFP? in the U.S., which it awards to individuals who successfully complete the CFP? Board's initial and ongoing certification requirements.

Tuttle Tactical Management (TTM) is an SEC-Registered Investment Adviser. Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser, tax professional and/or legal counsel before implementing any securities, investments or investment strategies discussed herein.

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