Hedge funds by another name

According to Mercer’s study of UK pension fund asset allocation, tactical asset allocation (TAA) is also anticipated to become more popular, with the proportion of schemes using TAA expected to rise from 3% in 2004 to as much as 10% this year.
David Tucker, of the UK arm of Australian firm Tactical Global Management, says interest from pension funds is spreading in Europe beyond the core Netherlands market. “We’re having a lot more enquiries in the UK now,” he says.
Goldman Sachs Asset Management has seen very concrete interest for global tactical asset allocation (GTAA), says Ruud Hendriks, head of institutional business development continental Europe (excluding Germany and Austria), the Middle East and Africa for the manager.
In recent years Goldman Sachs AM has won meaningful mandates in the Netherlands, the UK, Germany and other European countries. There is a lot of interest from pension funds around Europe and a desire for more knowledge about GTAA, says Hendriks.
How much can a client expect to gain from a GTAA programme? The value that Goldman Sachs AM can add with a GTAA programme varies depending on the targeted tracking error which the team is given by the client, says Hendriks. In any case, it is a volatile product, he warns, and people should think it over seriously before they put a GTAA strategy in place.
However, GTAA’s real advantage is that it is a “great source” of alpha that is not closely correlated with existing sources within a pension fund portfolio, he says.
TAA as practised a decade ago – and which yielded such disappointingly mediocre results – is very different from GTAA as available now, he says. Back then, TAA involved increasing or decreasing equities exposure within a portfolio. “You could only choose from one type of decision; it was a timing decision,” Hendriks says. “What we do with GTAA is take positions in the many equity markets, bond markets, and 10 different currency markets… we have many more areas in which we can take decisions.”
As well as this, in GTAA, Goldman Sachs AM tries to diversify its decision-making process over many factors. The quality of these decisions is better because there are so many more possibilities, he says. Essentially, what GTAA comes down to, he says, is valuing markets then overweighting the cheaper ones while underweighting the more expensive ones. GSAM comes up with the market rankings according to the factors it uses.
In many cases, TAA allows pension funds to reap the return benefits of hedge funds without having to openly challenge their prejudices about hedge funds. Tucker says there is no difference between a GTAA overlay and a global macro hedge fund. In fact, its TGM directional fund, a hedge fund, is identical to its GTAA overlay product. Only the name is different.
“A TAA overlay is a global macro hedge fund,” Tucker says. “But you can’t call it that.’
The marketing literature and presentations all refer to the product as a GTAA overlay because it is known that pension funds are very reluctant to put significant amounts of assets into hedge funds.
TGM says it can significantly increase portfolio returns with a GTAA overlay. If 4% of fund assets are allocated to the overlay, this can add between 70 and 75 basis points at the portfolio level, says Tucker. “So you’re looking for a return of 15% plus cash, which is on the same level as any global macro hedge fund.”
For a major client in Australia, TGM’s product has averaged a return of 15-16% annually over the past seven years. Fees are the same as they would be for a global macro fund, he says, though at the portfolio level these are, of course, much lower.
In terms of the risk level of a GTAA overlay, typically the information ratio is 0.8 and the Sharpe ratio 0.1.
The skills needed for any TAA manager are very much top-down and global macro, says Tucker. And there aren’t many managers around who possess these skills and can generate the returns. But TAA approaches do vary in the market, with some managers undertaking pure discretionary management, others largely based on technical analysis, whereas others are good momentum managers.
One of the main changes to this new current form of TAA compared with the traditional approach is that there is little link to the underlying benchmark of the pension fund. In a global macro-managed account style of TAA, the benchmark is cash. The focus is on absolute returns.
While in the traditional approach it is normal to have net-short-sell constraints – limits imposed to stop a TAA manager from going short in a position beyond the physical allocation to that market – in the global macro-managed account approach, there are none. This means ranges can be set which let the manager take symmetric long and short positions.
While this leaves the manager more free to pursue returns, a passive rebalancing overlay is added alongside that. “The passive overlay brings it back to benchmark,” says Tucker. So the global macro-managed account is run separately from the benchmark, but the passive overlay maintains the integrity of the GTAA overlay with the underlying pension fund.
The other major change in the way TAA is conducted now is the increased use of derivatives in the process, says Tucker. “Originally it used to be done in the physical securities,” he says, but with the broadening of the derivatives markets, it has become far more workable to use futures and forwards in the process.
TAA, in the form it is available now, is suitable for all sizes of pension fund, says Tucker. If the fund were to run a bespoke TAA solution, the assets involved would have to be at least $5m (E3.8m) – and if this were 4% of assets, then the pension fund would have to have total assets of at least $125m. With a bespoke solution, he says, there has to be a minimum size of assets involved because of the “lumpiness” of the underlying derivative contracts.
However, with the advent of pooled TAA vehicles, the minimum is now in the region of $100,000. “It opens it up to all sizes of pension fund,” Tucker says.
“It’s very important to have a strict investment process,” says Bo Sørensen, chief investment strategist and head of asset allocation at Danske Capital in Copenhagen. Though TAA is often seen as a mainly quantitative process, Sørensen says it is important to see both sides.
“We see it as a strategy that used quantitative as well as qualitative approaches,” he says. “If you are focused on only one of these then you will get into periods when you have trouble; if you are purely quantitative there will be times when your model is not working.”
Apart from the approach a TAA manager takes, it is also crucial that TAA is treated as separate discipline from other forms of asset management. There should be a team dedicated to TAA. “We see some places where TAA is a management decision, and this can be a bit dangerous,” Sørensen says.
In Denmark, there is some reluctance to use an external manager for TAA, as it is seen as an investment process the pension fund conducts itself. But slowly, this may be changing.
“In Denmark we can see that pension funds are a bit careful in buying external TAA because that’s what they do themselves – fund selection and asset allocation,” says Sørensen. “But we do see some movement and openness in trying to implement TAA.”
TAA is offered as an advisory or consulting product, he says, but there is also interest now in TAA as an overlay.

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