Tactical Asset Allocation in Volatile Markets

Consider a hypothetical investment management firm, WealthGuard, which manages a diversified portfolio for a high-net-worth client, Sarah. Given the current macroeconomic environment characterized by rising inflation, potential interest rate hikes, and geopolitical instability, the firm's chief investment officer (CIO) is contemplating an adjustment to the portfolio's asset allocation strategy. The CIO is considering a tactical asset allocation (TAA) approach to adjust the weightings of equities, fixed income, and commodities based on short-term market forecasts.

In your response, address the following:

• Define tactical asset allocation and explain how it differs from strategic asset allocation.
• Considering the current macroeconomic conditions, recommend specific adjustments to the portfolio’s asset allocation using tactical asset allocation principles. Provide rationale for each adjustment based on the prevailing economic indicators.
• Discuss the potential risks associated with TAA, including both systematic and idiosyncratic risks, and suggest risk management strategies that WealthGuard can implement to mitigate these risks.

Support your analysis with relevant financial theories and frameworks, such as Modern Portfolio Theory and behavioral finance insights.