Tactical Asset Allocation:

Using a Sector Prediction Model

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T Short Term Asset Management
Pedro Candas
Stepan Karpukhin
Yoshinobu Kataya
Robert Lee
Luis Shirley
 Agenda

• Objective
• Intuition
• Methodology
• Some of Our Models
• Data Analysis
• Comparing Our Model
• Results
• Conclusion

S
T Short Term Asset Management
 Objective

• Build a MSCI sector index prediction model

using lagged MSCI sector index returns.

• Build a tactical asset allocation strategy

using this prediction capability to
outperform a strategic asset allocation of
different MSCI sector indices

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T Short Term Asset Management
 Intuition

• Markets are highly inefficient

• Sectors are interrelated

– Chemical sector depends on the Energy sector
in their production process.
– Japanese industries are reliant on U.S. market

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T Short Term Asset Management
 Methodology

• Gathered monthly MSCI sector index

returns for Japan, U.K., and U.S. for 1990-
2000
• Identified industry sectors for analysis.
• Developed prediction models with lagged
industry data and other economic variables.

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T Short Term Asset Management
 Some of Our Models
Dependent variables Independent variables
• Japanese Financial Services Sector – Japanese Energy Sector(lagged)
Japanese Bank Sector(lagged)

• Japanese Chemical Sector – Japanese Energy Sector(lagged)

U.S. Energy Sector(lagged)
Oil Prices(lagged)

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T Short Term Asset Management
 Data Analysis

• Prediction models have up to a 64% hit rate

– Accuracy may have improved with different
economic indicators
– Accuracy may have improved with different
time frames on lagged data

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T Short Term Asset Management
 Comparing Our Model

• Benchmark- Mean Variance Portfolio of the

seven MSCI sector indices described in our
models(Strategic Asset Allocation)
• Who will perform better?
Strategic Asset Allocation
versus
Our Tactical Asset Allocation Model

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T Short Term Asset Management
 Results

• At the same standard deviation (.034):

– Benchmark: 11.1% annualized return
– Our model: 23.0% annualized return

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T Short Term Asset Management
 Results
Returns on Strategic and Tactical Allocations

800%

700%

600%
Portfolio Value

500%

400%

300%

200%

100%

0%
5/90 11/92 5/95 11/97
Date
Strategic Allocation Return Tactical Allocation Return

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T Short Term Asset Management
 Conclusion

• Predictive Models based on lagged sector

returns may prove significant
– Greater accuracy using different timeframes for
lagged returns data and better economic
indicators

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T Short Term Asset Management