GLOBAL TACTICAL ASSET ALLOCATION
A Is GTAA
S PENSION FUNDS across the globe
chase alpha, a growing number are
turning to global tactical asset alloca-
tion (GTAA) in a bid to extract added
value anywhere they can. The mounting
appetite for GTAA is reflected in a spate of
recent mandates handed out by high profile
pension funds across continental Europe and
the UK over the last year. The €64.7bn Dutch
pension fund PGGM has hired three
GTAA managers – Goldman Sachs Asset
Management (GSAM), Bridgewater Associates
and First Quadrant – since setting up its GTAA
overlay programme in 2004. In addition, the
€17bn Swedish AP2 tapped GSAM for a GTAA
brief while the £1.3bn Fujitsu Services Pension
Fund (UK) hired Barclays Global Investors
(BGI) to run a GTAA mandate.
It would appear that the number of GTAA
mandates awarded by pension funds this year
is waning in comparison to last year’s furor, but
managers insist interest remains stronger than
ever and say the strategy pension funds shied
away from just five years ago has huge growth
potential going forward.
“The interest in TAA overlay is consistently
picking up across every developed market in
the world,” said Michael O’Brien, managing
director, European institutional business, BGI.
“The number of high profile allocations hasn’t
been as high [this year] but at the root and
branch of the pension industry there’s still a
lot of interest and a lot of activity.”
Tony Broccardo, CIO of F&C, added:
“There’s a consensus that returns from market
places will be more normal, certainly com-
pared to the 1990s, and therefore the added
value from a well constructed asset allocation
and tactics will be proportionally more impor-
tant going forward than it has been for many
years.”
GTAA aims to add value by overweighting
attractive markets and underweighting those
considered to be overvalued, and can be
expected to enhance returns above the strate-
gic asset allocation – the neutral allocation or
pension fund benchmark. To date the substan-
tial risk budget and governance required to
implement the strategy has made it nearly
impossible for smaller pension funds to opt for
a tactical overlay. But John Collins, investment
consultant at Watson Wyatt, said the emer-
gence of pooled funds was seeing GTAA’s
appeal stretch beyond that of only the larger
pension funds. Five investment managers have
launched pooled GTAA funds in the last 12
months, he added.
“We are seeing more interest from smaller
clients who maybe wouldn’t have considered
the strategy and that’s partly facilitated by
managers offering pooled funds which makes
it easier for them to implement the strategy,”
Collins said. “It means you don’t have to set up
the same legal documentation that you would
have had to previously and it also gives clients
limited liability within the fund, which you
wouldn’t have had on a segregated basis.”
Another benefit of pooling is that it means
clients do not put excessive restrictions on the
manager, he said: “If you believe you have
appointed a skilled manager it makes sense to
allow them to take all the positions they wish
to. We believe restricting a skilled manager
could actually be negative in terms of the types
of returns you will receive.”
Adding value
According to Richard Turnill, head of asset
allocation and economics, Merrill Lynch
Investment Managers (MLIM), there are two
ways to add value through GTAA.
“For a pension fund, you can either use the
inefficiencies within the market to try to
enhance returns over time, or increasingly,
you can use those inefficiencies to achieve a
40
still the way
forward?
Global tactical asset allocation (GTAA), which
experienced a kind of renaissance last year, is still
on the agenda for pension funds. Kristen Paech
reports on the changing face of GTAA
target return but to minimise volatility within
portfolios.”
During the equity bull market in the 1990s,
the need for such a strategy was perceived by
pension funds to be benign. Turnill said the
possibility for funds to earn high returns with
a passive asset mix meant there was less desire
to look at alternative return-seeking assets.
“Going through the bear market, it’s become
clear that simply benchmarking to an index is
not the right solution for many pension funds
when that index is falling very sharply,” he
said.
Additionally, the equity and bond markets
were highly correlated, resulting in a lack of
investment breadth, making it harder to add
value. But consultants say pension funds are
beginning to regain confidence in GTAA as a
source of alpha with the strongest interest
coming from the UK. “Historically, the main
interest for GTAA has been in Australia, but
more recently it’s becoming more popular in
the UK,” said Bill Muysken, global head of
research, Mercer Investment Consulting. “In
Australia, when the market moved from bal-
anced to specialist management in the mid
1990s, clients making that move wanted to
retain an element of TAA in their manager
structure. In the UK, however, balanced man-
agers in general haven’t done a good job of
TAA so when the UK market moved from bal-
anced to specialist, it was normally on the basis
that asset allocation was passive. People have
now realised that just because balanced man-
agers in the UK tended to give TAA a bad
name, that didn’t necessarily mean that TAA
was a bad thing.”
Tony Broccardo, CIO at F&C Asset
Management, said lower expected returns
from equities had also prompted pension
funds to consider GTAA as a means to hedge
away their equity risk.
“It’s a natural and correct reaction to the
undue focus placed on growth equity strate-
gies in the late 1990s,” he said. “GTAA is seen
as the mechanism for controlling the various
risks within a multi-asset portfolio – it’s that
realisation that the risk side needs to be man-
aged as well as the return side which has
brought GTAA centre stage.”
GTAA overlay
The majority of pension funds that hire GTAA
managers choose to implement the strategy as
an overlay, as opposed to investing in a fund.
Generally, the overlay approach is considered
simpler and more cost efficient than trading
physical assets. Marc Nuijten, head of deriva-
tives and overlay management, PGGM, said:
“Using a derivatives overlay structure, we were
able to implement unfunded mandates which
is very efficient from a cash perspective. Also,
the derivatives market is very liquid, so it’s pos-
sible to implement strategies over a short peri-
od of time.”
Turnill of MLIM said pension funds and
trustees had recognised that physically buying
and selling assets, particularly if those assets
are handled by different managers, was a very
difficult and expensive way to implement
GTAA.
“They are now using TAA overlay – it’s a
more cost efficient, cheaper and quicker to
implement, and it fits in very well with a struc-
ture where you have a series of specialist man-
agers managing the underlying assets,” he said.
O’Brien from BGI said in the past GTAA was
done on a long-only and funded basis.
Nowadays, overlays are generally executed syn-
‘People have now realised that just
because balanced managers in the UK
tended to give TAA a bad name, that didn’t
necessarily mean that TAA was a bad thing’
GLOBAL PENSIONS
thetically and on a long-short basis.
“If you bought US, you basically bought the
dollar and the US equity market in one single
bet,” he said. “What we’ve seen over the last
five years is that TAA has been re-invented in a
long-short world, so you separate out all the
countries from all the equity, bond and cur-
rency markets and you manage those on a
long-short basis.”
O’Brien believes this evolution of TAA has
markedly improved the value added proposi-
tion for managers: “On a long-short basis, the
information ratio you can get from GTAA - the
return divided by the risk – is around 1,” he
said. “So you’ve got a low correlated strategy
that has a high information ratio and has low
frictional costs of implementation. That’s a
very good proposition.”
Risk management
One of the issues for pension funds to consid-
er when implementing GTAA is risk manage-
ment. GTAA is one strategy where you can
scale the amount of risk you allocate to the
strategy to get the risk exposure that you want
but as Collins from Watson Wyatt explains, you
need to be aware of the volatility levels of the
funds you’re investing in.
“Rather than just saying I’ll allocate £50m to
the strategy, you need to be aware of how
much risk you’ll take,” he said.
“Different managers have different levels of
volatility in their funds so you need to scale the
amount you commit to the strategy according-
ly. In terms of the risk budget, you have to con-
sider how much risk you have got in all the
strategies and how much is concentrated in
each of the individual strategies to make sure
you’re not overly reliant on any one particular
strategy.”
Another factor that must be taken into
account is the design of the mandate. Muysken
from Mercer said design can have as much
impact on performance as the choice of man-
ager.
“In designing the mandate, I would say resist
the temptation to place too many constraints
on the manager because it will hurt their per-
formance over the long term,” he said.
Alistair Lowe, director of global asset alloca-
tion at State Street Global Advisors (SSgA) in
Boston, agreed investment breadth was a vital
part of the mandate structure.
“People are looking to have as many inde-
pendent sources of alpha as they can, so mix-
ing everything from equities, market neutral,
active fixed income, currency management
and GTAA within an overall portfolio context,”
he said. “GTAA strategies do well at different
times from equity market neutral strategies
and that lack of correlation gives them better
diversification of their alpha.”
As pension funds struggle to meet the con-
flicting aims of managing risk and enhancing
returns, managers and consultants predict
increasing numbers will turn to GTAA.
“There’s a balance between closing down
risk from a liability point of view, which tends
to mean minimising interest rate risk in a port-
folio, but at the same time, creating part of the
portfolio to add value,” said Broccardo from
F&C. “It’s within that growth part of the port-
folio that we think GTAA will get a decent slice
of the value added proposition.”
Bill Muysken, Mercer
SEPTEMBER 2005