Long term asset allocation is established on the basis of careful analysis. There is a careful weighing of the trade-off between risk and return keeping the long-term objective of the investment plan in perspective. Here the short-term adjustments are handled through cash flows rather than through a formal analysis. This ad-hocism could result in errors.
Tactical asset allocation provides the structure and a disciplined framework to prevent such errors. In tactical asset allocation the investor could also use futures to enable short-term adjustments in the portfolio at very low transaction cost.
A question comes to mind: Are we able to add value to the portfolio by changing its asset mix? The answer is 'Yes'. Consider the following:If in the equity market, one stock becomes undervalued relative to a second stock. Then money would flow from the second stock to the first, to bring it up and back to its fair value.
This flow of money ensures that the securities do not stray very far from their fair value over time and evaluation or price. We must note here that this flow of money has taken place within an asset class.
However, such flow from one asset class to another are fewer and far between. As for such money flows to occur a change would be required in the long-term asset allocation of the portfolio. Which would further require a change in the over all long-term investment plan and objectives. Some flows do occur between the asset classes, but they are gradual and moderate. This is also to explain that if money flows did not occur among the asset classes, then the markets would sway away from their fair value.
By observing the above we realize that asset allocation itself represents the greatest opportunity to enhance portfolio performance in the securities market.