This Portfolio Strategy Aims To Ride Market Trends And Sidestep Crashes

The Defensive Asset Allocation tactic could be a useful addition to your investing toolkit.

Tactical asset allocation strategies are “dynamic” investment methods – ones where you're actively adjusting your portfolio to take advantage of market trends, aiming to maximize returns while minimizing risks. These approaches are relatively easy to implement using ETFs, and some of them have very impressive track records. One that recently stood out for me is the defensive asset allocation (DAA). Here's how it works and how you can add it to your investment toolkit.

What are the basic concepts behind the DAA strategy?

DAA is a “momentum strategy”, and that means you invest in asset classes that have recently performed well, based on the assumption that they’ll continue to perform well in the near future. Momentum is a well-studied phenomenon within the academic and finance communities. One of the reasons it works is the fact that investors have deep behavioral biases – like herding and extrapolation.

There’s another neat concept embedded in DAA: a market timing signal as a way to sidestep crashes. That is, the tactic tries to shift to safe-haven assets (like government bonds) when a market crash is imminent. It does this when certain groups of assets – which the strategy refers to as a “canary universe” – start to display negative momentum. This functions as an early warning system to exit the market, like the proverbial canary in the coal mine.

Credit where credit is due: DAA comes from Wouter Keller and JW Keuning's research paper, “Breadth Momentum and the Canary Universe”.

Which asset classes does DAA trade?

DAA trades 16 different ETFs, each representing a different asset class or subclass. The 16 ETFs are organized into three different groups, or “universes”: risk, canary, and cash.