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Tactical Asset Allocation Is Latest Wall Street Craze

JOHN CRUDELE <i> is a financial columnist for the New York Post. </i>

One day a few weeks ago, Wall Street was having an awful morning. The Dow Jones industrial average--the market indicator that everyone watches--was down more than 17 points before lunchtime.

But suddenly from out of the blue, in the early afternoon, rode the market’s newest White Knight--someone called a tactical asset allocator. By mid-afternoon the Dow was climbing steadily and by the close of trading the indicator was up as much as it had been down.

Tactical asset allocation is the hottest thing on Wall Street these days. So it seems fitting that the concept is starting to fuel one of the hottest debates on Wall Street. Is tactical asset allocation a magical way to invest, or a sham?

In concept, tactical asset allocation is simple: An investment manager “allocates” a certain portion of the money under his care to stocks and bonds based on how each market is doing. That’s what investors have always done.

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In theory, however, the newest version of asset allocation is a little more complicated: Each asset allocator has developed complex computer models that purportedly tell him the historical relationship between stocks and bonds as well as the relationship between the domestic and foreign financial markets. Using the models, these advisers claim to know when to readjust the amount invested in each market.

Market Distortion

To the believers in tactical asset allocating, it is a godsend--a nearly foolproof, scientific way to invest.

But not everyone is a believer. In fact, detractors are getting more vocal by the day.

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Some critics think that tactical asset allocation is, pure and simple, a fad that will be exposed as worthless the next time that the stock market goes down.

Others go a step further, saying that tactical investing could make the next market slump even worse because this type of scientific investing is helping the stock market rise right now to record levels without a sound fundamental foundation for the gains.

“Tactical asset allocation,” says one trader, “throws off your fundamental thinking.”

“It distorts the market. The tactical traders are ignoring future earnings prospects because their models look back into history. They could be keeping the stock market up when fundamentals are deteriorating and the market should be going lower,” the trader adds, while admitting that he has lost money because of the tactical traders over the past few weeks.

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While that trader could be accused of sour grapes, there are others without a vested interest who criticize tactical asset allocation. They say that the intermarket relationships set up by the tactical asset allocators are phony and that those who invest by the numbers will be very disappointed in the long run.

“My basic feeling about (tactical asset allocation programs) is that they are probably good for attracting clients, but I’m skeptical over the long run that they will be a wise way to manage your money,” says William Nordhaus, the John Musser professor of economics at Yale. He adds that his own work shows that this type of investing “breaks down” as you project it into the future.

Nordhaus adds: “I regard it as faddish. It is the latest gimmick. I guess it will catch on, (but) a lot will depend on how lucky the people are who run it.”

History Repeats Itself

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Others are less kind. “First of all, the idea that you can successfully quantify the investment process, like the tactical asset allocators say they do, is foolish,” says Hugh Johnson, chief investment officer of First Albany Corp. “The idea that you can reduce investing to a simple formula or rely on a black box that is the financial equivalent of the Holy Grail is a bit grandiose.”

Experts estimate that there is currently between $40 billion and $50 billion under management by tactical asset allocators. The biggest asset allocation funds are said to be run by Wells Fargo, Mellon Bank, J. P. Morgan & Co., The Boston Co., First Quadrant Corp., TSA Capital Management and Chancellor Capital Management, formerly a unit of Citicorp.

It’s difficult to say just when tactical asset management got its start. Financial technicians have always tried to time the peaks in the various markets, and in a sense they are the pioneers of the industry.

But tactical asset allocators claim to do a lot more than the old-fashioned market technicians. Part historian, part market prognosticator, the asset allocators claim to have the process down to a formula.

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Renaissance Investment Management Inc. of Cincinnati was one of the first to start this formula type of investing back in 1978, and it is still one of the biggest.

Frank Terrizzi, its president, says that the underlying premise behind tactical asset management is that financial history repeats itself. “We don’t impose any human judgment, which at times people say is foolish,” says Terrizzi, who sticks to his formula through thick and thin. He even missed the current run-up in stock prices because his computers told him to invest 100 percent in cash last January.

Potential Problems

Some proponents of this type of investing are trying to dispel the notion that asset allocation strategies are devoid of any connection to real-world events, like economic downturns. “We do rely heavily on history, but we do recognize its limitations,” says Robert Arnott, president of First Quadrant Corp. “There are pitfalls in an over-reliance on history.”

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The big question on everyone’s mind is: Could these tactical asset allocation programs ever contribute to another stock market crash, like many believe another fad called portfolio insurance did in 1987?

The experts say that right now tactical asset allocation isn’t widespread enough to be a real threat. And even if it does grow, it is unlikely that the sundry formulas being used would be triggered simultaneously.

But one never knows. The asset allocators could start the stock market on a slide that could be aggravated if other regular investors joined in.

Twelve months ago, Sci-Med Life Systems Inc’s stock was trading at around $15 a share. Earlier this month, the stock peaked at $75, and last week it was still selling in the very lofty mid-$60s.

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Even more amazing than the rise in the stock’s price is the fact that it hasn’t--yes, hasn’t--been the result of takeover speculation. Sci-Med is moving up for a good old-fashioned reason--its earnings are improving beyond Wall Street’s wildest dreams.

Sci-Med is a little-known Minneapolis-based company that makes medical equipment, especially oxygenators (artificial lungs) used during coronary bypass surgery and balloon catheters used to open up arteries as an alternative to bypass surgery. It’s stock was the fourth-best performer in the United States last year, and it is doing even better this year.

Analysts estimate that Sci-Med, through dogged determination, has managed to capture about one-tenth of the $400-million worldwide catheter market. C. R. Bard Inc. and Eli Lilly are estimated to equally share 80% of the market for that product.

“Sci-Med’s revenues and earnings have been growing very, very rapidly,” says Edward Mutsch, an analyst with Piper Jaffray Hopwood in the company’s hometown. Late last month, Sci-Med announced that earnings for its fiscal first quarter that ended in May were 82 cents a share. Since Wall Street had been expecting profits to be only around 50 cents, Sci-Med’s stock soared about 50%.

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And while the rich stock price is making some analysts and investors nervous, the company’s performance to date is allaying some of those fears. “If you believe this kind of growth is sustainable, I don’t think the stock is overpriced,” says Carol Winslow of Dain Bosworth Inc. “I guess I don’t believe it,” she says, adding that she recently rated the stock a “hold” but isn’t recommending that clients buy any more of it.

“I would call it a very speculative buy at this moment because of the price,” Winslow says.

Don’t be surprised if you hear takeover rumors about Sci-Med begin some day. Twice in the past couple of years, Sci-Med’s management has agreed to sell the company, but neither deal went through. The only difference now is that Sci-Med’s stock is a lot more expensive.

‘Our company’s position has always been that we will do what’s in the best interest of shareholders,” says Craig Dworak, chief financial officer of the company. He won’t say, however, whether anyone has approached Sci-Med about an acquisition lately.

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Drexel Burnham Lambert says the institutional investment decision-makers it polled in June were more positive about the bond market going up (and interest rates going down) than at any time since August, 1986. Drexel, however, points out that the majority were wrong in 1986--interest rates rose sharply from mid-1986 to early this year . . .

Honeywell’s decision to sell most of its Yamatake-Honeywell subsidiary and buy back a massive amount of its own stock has Wall Street searching for other corporations with Japanese subsidiaries that aren’t vital. One is NCR Corp., the Dayton, Ohio, technology company that owns 70% of NCR Japan, which could be worth $1 billion or $17 for each NCR share outstanding . . .

An investment banker expects takeovers to boom in England, if that country’s government doesn’t give Sir James Goldsmith a hard time over his bid for B.A.T. Industries . . .


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