Asset Allocation
Will GTAA Prove Itself?
GTAA, has not been standing still but has evolved in some new directions that reflect investors’ desire for a more opportunistic approach—and lower costs.
Reported by Eric Laursen
Some investors disagree. Tactical asset allocation and GTAA are now a mature set of strategies, they say, that have proved their worth at times when markets are floundering. TAA aims to reduce volatility and preserve capital during market declines, which it did in the painful period following the 2008 crash, and for many institutions that have a long history with the strategy and a strong emphasis on risk management, it continues to be a central element of their long-term investment approach.
American investors pulled $36.8 billion out of GTAA strategies in 2016, according to eVestment. The trend appeared to continue in the first quarter, when one of the bigger US institutional investors in GTAA, the $13.2 billion Orange County Employees Retirement system, completely eliminated its $791 million allocation. The booming US stock market, along with high fees on some GTAA strategies, are among the reasons consultants and plan sponsors cite for the moves.
The $3.8 billion Houston Firefighters’ Relief & Retirement Fund, however, announced last fall that it had engaged State Street Global Advisors to run a $200 million GTAA strategy. The $2.4 billion Municipal Fire & Police Retirement System of Iowa (MFPRSI) has been using GTAA managers since 2003 and five years ago increased its portfolio allocation to GTAA from 30% to 35%. The fund has no intention of scaling back, according to Executive Director Terry Slattery.
Who’s fleeing GTAA and who’s not varies geographically, too.
Holding Firm
Why, then, are assets fleeing GTAA? “Generally this trend is consistent with what we’ve seen across all actively managed strategies, not just GTAA,” says Kristin Reynolds, a partner at investment consultant NEPC, adding that “pressure” on GTAA managers “may ultimately lead to some industry consolidation.” A step in that direction may have been taken in March, when one of the biggest global GTAA managers, Standard Life, announced it was merging with Aberdeen Asset Management. Standard Life saw net withdrawals of £4.3 billion last year from its flagship Global Absolute Return Strategies (GARS) family of funds. The deal would create one of the biggest global money managers, with £581 billion in combined assets.
“Most of our clients have maintained their commitment to the space,” however, Reynolds says. “We tend to believe that investment managers who are thought leaders, are willing to be contrarian, and who take a disciplined and defined investment philosophy that they will maintain in the face of a difficult business environment, will ultimately benefit from this trend.”
Who’s fleeing GTAA and who’s not varies geographically, too. In the US, where GTAA has only become a popular strategy over the last dozen years, investors withdrew more than $36 billion in 2016. In the UK, where the strategy has been a fixture for much longer, outflows came to only $1.6 billion, and Europe as a whole saw inflows of $2.7 billion, according to eVestment. Market conditions are quite different in the three regions: a booming stock market makes diversified, risk-conscious strategies like GTAA less immediately attractive in the US, institutional portfolio managers and their advisers say, while the UK is reckoning with the untangling of its relationship with the EU and Europe is still finding its way through a painfully drawn-out economic recovery.
“The risk with any approach like GTAA is that it requires a long time horizon to see if it’s adding value in the context of your portfolio,” notes Joe Nankof, a partner at Rocaton Investment Advisors. “The last three to five years is not a long enough time horizon; you need five to 10 years, because GTAA can be out of favor for an extended period time.” MFPRSI has been practicing the strategy for over a decade, for example.
GTAA Fund Flows
Size also makes a difference. “You can get equity-like returns with hybrid strategies like convertible bonds, preferred equity, collateralized loan obligations—we have some clients investing in them—and credit-oriented strategies—if you have a time horizon beyond five years and you have sufficient capital to take advantage of them,” says Nankof.
“With MACS, investors are able to stick with a diversification strategy while being more opportunistic,” Barron says.
Funds that have shed their GTAA commitments may be focusing too narrowly, however. “It’s true that diversification is overrated right now; it’s failed over the last three to four years,” says Tim Barron, senior vice president and CIO at Segal Marco Advisors. But that’s just for equities. “Diversification in the bond portfolio, away from US Treasuries and into smaller credits, has been a winner.”
GTAA, meanwhile, has not been standing still but has evolved in some new directions that reflect investors’ desire for a more opportunistic approach—and lower costs. Some managers offer risk parity and some are not pure active managers but have passive exchange-traded funds as a component.
“We’ve observed the proliferation of more factor-based strategies that employ techniques associated with alt- or smart-beta strategies,” says Reynolds. “This seems driven by an emphasis on technology innovation by managers and a focus on fees from investors. Generally, we’ve also seen some strategies be more flexible with fees and associated structures—partially as a reflection of a lower return environment for most risky assets going forward, but also as a result of client and performance pressures.”
MFPRSI is 81% funded and is pursuing a long-term strategy to get to full funding within 25 years. That puts a premium on diversification and using tactical moves to reduce risk. The fund splits its GTAA portfolio between three managers with distinct approaches to the practice, Slattery notes: GMO LLC, a value manager with an often bearish bias; J.P. Morgan Asset Management, which veers more toward the bullish; and Schroders Investment Management, which it hired almost two years ago and which follows a style “based on identifying acceptable risk premiums, then assembling a diversified portfolio geared to avoid deep downdrafts.”
Art by Adam McCauley
MFPRSI refers to the three as “strategic” managers, but the fund follows a GTAA approach by allowing them to control risk by “making subtle moves in their portfolios based on what they anticipate from market trends to overweight positive asset classes and underweight those they expect to lag.” While the core portfolio is constructed as a 75% global equity, 25% global fixed income mix, aiming to gain alpha over a comparable global benchmark, the strategic managers can invest in hedge funds, derivatives, and cash equivalents as well.
The approach appears to be working. A recent study by MFPRSI’s investment consultant, Summit Strategies, compared returns for the strategic managers and those making up the fund’s core portfolio—largely global equity and fixed-income managers.
Some advisers see the strategy as a more natural rival to hedge funds, promising lower fees and less volatility.
“The strategic managers outperformed in volatile markets over a 10-year period, with a higher Sharpe Ratio and lower tracking error than our core portfolio,” Slattery says. “So we feel there is a balance in the portfolio—that our core managers do better in booming markets while our strategic managers do better in volatile markets.”
The emphasis on risk control is even more critical at the £23.4 billion Pension Protection Fund, which was established in 2005 to protect members of UK defined-benefit pension schemes should their sponsoring employer become insolvent, analogous to the Pension Benefit Guaranty Corporation in the US. Here, GTAA is not an add-on portfolio but a fundamental part of the fund’s investment and risk control structure.
The PPF currently has more than 225,000 members including current workers and pensioners who rely on it to assure payment of benefits. About half the fund’s assets are in a liability-driven investment (LDI) portfolio, including gilts, inflation swaps, credit default swaps, and other long-duration assets designed to match a 50-year projected stream of liabilities. The PPF also runs a return-seeking portfolio that in turn is roughly evenly divided between illiquid assets like real estate, farmland, private equity, and alternative credits and a second, tactical subset including publicly traded equities, credit, and government bonds. The non-LDI portfolio aims to deliver an additional return over what’s needed to cover liabilities while maintaining relatively conservative risk limits; “the more liquid part allows us to be more tactical when we see opportunities,” says Ian Scott, head of investment strategy.
Or to respond to market disruptions. “Nobody could claim that we saw Brexit coming, but the fund is structured to withstand such unexpected events,” with the result that “all through that period, the fund matched its liabilities; at no point were we not fully hedged,” says Scott. This is critical, he points out, because claims tend to go up at times when the UK economy is weakening, “and we don’t want to be invested in assets that are doing badly at times when claims are going up.” To further ensure that assets remain relatively uncorrelated with the ups and downs of the UK economy, both parts of the non-LDI portfolio invest in a global mix of assets.
This structure has helped the PPF to achieve a funding ratio of 129% for pension schemes that have failed and the liabilities transferred to its control at the end of 2016 while over the last three years.
Its return-seeking assets have outperformed liabilities by 2.4% annually over LIBOR or 60 basis points over the fund’s investment target.
MACS Attack
Some, at least, of the money exiting GTAA strategies may be going into something more similar: multi-asset class strategies (MACS). American investors poured $1.4 billion into multi-asset strategies, exclusive of TAA portfolios, last year, the vast majority of the inflows coming in the fourth quarter, eVestment reports, although UK and European institutions were net sellers.
“We’re finding increased interest in MACS among the asset managers we work with,” Barron says. Reynolds concurs, attributing growth in MACS allocations to “more investors using multi strategy to complement hedge fund mandates in portfolios.”
Like GTAA, MACS portfolios are global and invest across a range of traditional and alternative asset classes with the aim of both boosting return and controlling risk, especially during market disruptions. But they tend to be more opportunistic and more intently focused on returns and to define their goals differently, Barron notes. While GTAA portfolios generally adhere to a traditional 60/40 split between equity and fixed income holdings, most MACS aim to deliver a target return above a benchmark—say, 4% over the CPI or 7% over Treasury bills. That makes them a good fit for institutions with an LDI focus and a desire to reduce volatility.
Multi-Asset Fund Flows (ex-TAA)
“MACS is a way to manage complexity,” says Barron—for example, in a moment like the November presidential election, when “it’s hard for the board to respond on short notice.” Typically, MACS supply the strategy for swing portfolios that are carved out the fund’s equity and bond allocations and that have greater liquidity and greater leeway to make opportunistic moves at key moments—without the need for the board to agree on a major change in overall asset allocation.
What the movement of funds into MACS indicates is not a rejection of the concept behind GTAA—“GTAA is MACS in the most simple form,” says Barron—but an acknowledgment that more investors are shifting from a more constrained to a more opportunistic approach. “With MACS, investors are able to stick with a diversification strategy while being more opportunistic,” Barron says.
Some advisers see the strategy as a more natural rival to hedge funds, promising lower fees and less volatility. “We don’t make a distinction between GTAA and MACS,” says Reynolds. “As a result, we see GTAA/MACS as liquid/less complex versions of hedge funds, meant to offer a diversified return stream and move in and out of asset classes at their discretion.”
A greater concern for institutions that thought they had found the answer to their need for incremental returns and risk protection in GTAA may be the difficulty of finding a manager that offers the right level of both. A recent study by Markov Processes International found that a range of leading GTAA funds displayed widely different levels of volatility over a four-year period, from a 3.6 standard deviation for John Hancock’s GARS fund (subadvised by Standard Life Investments) to 9.7 for Ivy Asset Strategy. Returns varied dramatically too, from 6.7% for J.P. Morgan Global Allocation Fund to -1.1% for PIMCO All Asset All Authority Fund.
That’s not surprising, given that GTAA managers are evolving their strategies in an effort to differentiate themselves from a more crowded field; institutions that want to adopt the strategy will simply have to scrutinize the range of options more closely going forward. Long-term, however, the experience of MFPRSI and the Pension Protection Fund suggests that the need to make assets cover future liabilities may keep coming back to GTAA—or something much like it.