GTAA (Global Tactical Asset Allocation) is an
investment strategy that attempts to exploit short-term market
inefficiencies by taking positions in various markets with a view to
profiting from relative movements across those markets. The approach
focuses on general movements in the markets rather than on performance of
individual securities within them Positions are generally taken with a
relatively short-term time horizon (3 – 6 months) –
hence the term
Tactical Asset Allocation – and in markets
across the globe – hence the term Global.
Positions are invariably implemented via
derivatives, for example, selling futures on markets expected to
futures on markets expected to outperform.
Traditionally, positions have been largely limited
to major world equity and bond markets as well as currencies. More
recently, many managers have broadened their opportunities set, and
strategies may now include any of the following: emerging market equities,
debt and currencies, commodities, industries/sectors of equities markets,
. small equities,
credit spreads and yield curves.
GTAA shares some of the characteristics of, or can be
seen as having developed from, Global Macro Hedge Funds and tactical asset
allocation (TAA) decisions implemented by managers of multi-asset or balanced funds.
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Global Macro Hedge Funds
Like GTAA, Global Macro Hedge Funds aim to profit
from taking positions in major world equity, bond or currency markets.
Global Macro, however, has been characterised, at least in public
perception, by large, undiversified bets, for example Soros vs
. the Bank of England. Modern GTAA
strategies are generally well-diversified and operate with strong risk controls.
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TAA activity within multi-asset funds
TAA decisions undertaken by managers of multi-asset
funds are, like GTAA decisions, intended to enhance investment outcomes by
overweighting and underweighting asset classes, depending on the expected future
performance over relatively short time periods. TAA within multi-asset funds is,
however, limited to the asset classes contained in the fund’s strategic asset
allocation, whereas most GTAA strategies access a broader opportunity set. Also,
GTAA is being undertaken as a specialist activity by teams applying substantial
resources to the task. TAA decisions implemented within multi-asset funds were
in the past frequently taken by committees of asset class specialists primarily
focussed on managing portfolios in their respective asset classes.
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How can investors use GTAA
Investors can incorporate GTAA into their investment
structures either by investing in a GTAA fund or by utilising a GTAA overlay service.
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These funds typically incorporate a high degree of
leverage and therefore generally have demanding investment objectives with
corresponding high volatility. For instance, an investment objective of cash
plus 15% pa and expected volatility of 15% pa is common. Accordingly, even if
the proportion of a plan’s total assets invested in such a fund is small, the
potential return (and contribution to risk) at the overall plan level can be significant.
Due to the volatility, we normally recommend that the
allocation to GTAA funds be limited to a small proportion of total assets (up to
5%), although this depends on risk appetite and the specific risk budget of the
pooled fund. The investment should ideally be spread across 2 – 3 funds to enhance diversification.
Compared to overlays, the key advantage of GTAA funds is
their administrative simplicity. Indeed, the mechanics are similar to investing
in any pooled investment vehicle. Some funds are, however, domiciled in offshore
locations, and this may raise unusual due diligence issues.
The main drawback is that it is not possible to tailor
the strategy to an investor’s particular circumstances. This drawback is
becoming of less relevance over time as an increase in the number of credible
funds is providing greater choice for investors.
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Under a GTAA overlay, a manager is appointed to
manage a portfolio of derivatives contracts, which are entered into in the
plan’s name. A cash balance of 2 – 3% of plan assets is allocated to the
manager for the purpose of meeting deposits and margin calls on those
contracts. If desired, this cash can be equitised
Arranging and monitoring it over time is more complex
than investing in a GTAA fund. As well as an Investment Management Agreement
with the manager, credit limits must be established with counterparties to the
derivatives transactions and a custodian is required to settle trades and report on positions.
The main advantage is the flexibility to tailor the
mandate to the investor’s particular requirements.
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Why invest in GTAA
It is widely acknowledged that many institutional
investment portfolios remain dominated by equity and interest rate risk, and
that these allocations tend to remain static over time irrespective of market
conditions. Unless a strict liability matching approach is to be taken, there is
merit, therefore, in establishing a portfolio of alternative alpha sources.
We consider that GTAA represents an attractive alpha
source for the following reasons:
The performance differentials between asset classes
are frequently substantial.
The derivative instruments used in GTAA are mostly
highly liquid and transaction costs are low.
The volume of assets managed with a focus on
relative performance of asset classes is low compared to that focussed on
finding opportunities within asset classes.
A number of managers with very impressive teams,
processes and track records can be identified. There are many managers with less
impressive credentials also – no surprises there.
Furthermore, the analysis and decision making involved
in GTAA is focussed on cross-market comparisons. This is very different from the
comparison of securities within given markets, which is the focus of active
management within traditional asset classes, and of many hedge fund strategies,
for example, market-neutral, convertible arbitrage. Accordingly, GTAA should be
a good diversifier, particularly within an alpha portfolio.
In addition, with the widespread adoption of sector
specialist investment arrangements, the TAA function previously performed by
balanced managers is no longer provided for. Balanced managers’ TAA decisions
have, in many cases, not been particularly favourable over time. Nevertheless,
given the acknowledged importance of asset allocation, many trustees will draw
comfort from having an element of TAA expertise deployed within their investment
structures. And we consider that the use of leading specialist GTAA managers is
a vastly preferable way in which to access this expertise.
Many of the arguments favouring GTAA also apply to
active currency management. GTAA managers have a broader opportunity set than
that available to a currency manager. Indeed, GTAA managers invariably include
currency as part of their process and often expect to source around 30% of their
value added from currency decisions. Provided that the manager’s skill in
currency and in broader GTAA decisions is equal, the broader opportunity set in
GTAA can be expected to lead to more reliable added value.
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GTAA strategies provide investors with a series of
exposures that may not otherwise be present in their portfolios. Managing these
exposures, which are usually in liquid markets with low entry and exit costs,
provides an opportunity for the generation of active returns that are likely to
be lowly correlated with other sources of active return. However, specialist
skills are required to access these opportunities.