Looking at the dynamics
While the message is gradually getting through that tactical asset allocation (TAA) has evolved and improved since the early 1990s, consultants say this new investment method has yet to prove itself in the long term.
Andrew Kirton, UK investment consulting practice leader at Mercer says TAA is back on the agenda for UK pension funds – at least in the form of flexible asset allocation or dynamic asset allocation.
However, TAA has traditionally been used to describe short-term changes to portfolios based on the day-to-day value of investment markets. “Investment managers used to engage in TAA in the days of balanced investment briefs,” he says. But virtually all the data suggested that most managers made no money out of it.
Now, with balanced briefs out of favour and pension funds instead being carved up into specialist briefs, the scope for TAA has diminished substantially, says Kirton.
The question in trustees’ minds is not do we want to return to the days of TAA, but how to deal with the risks of the very rigid structures that are now in place? “We’ve moved from one extreme to the other.”
Kirton asks: “We know that once in a while markets do really get out of line. Instead of just blindly letting this influence our returns, is there anything we can do?” Questions need to be asked, such as, if the 20th century was America’s century, will the 21st century be China’s? This, he says, is what dynamic asset allocation is about.
“We believe there are a very small number of TAA firms that can do overlays that can add value,” he says. But this is an investment niche. “There are very few funds that have a TAA overlay in place.”
Kirton adds: “We are seeing more in terms of currency management in place.” Mercer is a big supporter of this. “We do think value can be added in currency management.”
TAA is a very skilled investment area, Kirton says, and the managers tend to use quant methods. The models employed these days have been improved quite substantially since the late 1980s and early 1990s. There is a better chance now of finding a good TAA manager, he says, but there is still only a handful of pension funds in the UK doing it.
“Philosophically, short-term trading activities do not sit that comfortably with pension funds, being relatively long-term investors,” he says. But apart from this, there are other barriers to using TAA, citing the performance history and the collective memory of the industry.
Mercer has compiled data on returns achieved by providers of global TAA, and shows the return every manager earns relative to the their benchmark. The results are mixed, but since March 2003, returns have been good. “Particularly in the last two years, it’s been quite good for adding value,” says Bill Muysken at Mercer.
Mercer’s research took in data from 13 providers of TAA: Analystic Investors, BT Financial Group, Barclays Global Investors, Bridgewater Associates, Deutsche Asset Management, First Quadrant, GMO, Goldman Sachs Asset Management, JP Morgan Fleming Investment Management, Mellon Capital Management, State Street Global Advisors, Tactical Global Management and TAL Global Asset Management.
Eric Lambert, head of performance consultancy at the WM Company, says meaningful TAA went into decline five years ago. Now, he says there is more TAA happening. “People are desperate to get sources of return,” he says, and this has led them to use currency overlays and other methods.
TAA is a very skilled investment discipline. “It’s right up there at the top of any investment management skill, and that’s why it lost favour for a time,” Lambert says. WM’s analysis showed that it was hard to find an asset manager who could consistently add value through TAA.
Now, in the era of specialist mandates, there is less opportunity for asset managers to add value through TAA. Back when there was more balanced management, managers had control over weightings, but now there is very little scope. “The benchmarks are very specific… there is quite a tight discretion around them,” says Lambert.
TAA in the form of an overlay, in which derivatives are employed, is used by some pension funds, but whether this really adds value remains to be seen. “It works in the sense of achieving control, but whether it works in terms of adding value is still open to question,” he says.
So, while there is interest in TAA among pension funds, and some mandates, there is still a big question mark over whether the returns are worthwhile. “It’s right in principle [that pension funds are trying_TAA],” says Lambert.
TAA as an overlay suits pension funds which have a certain structure, though smaller ones may not be able to use it. “Funds of £100m (E145m), for example, can’t have a raft of 10 managers and then an overlay,” he says. In general it is the bigger plans that would do TAA. It is probably inapplicable under £500m (e728m). “Beneath that, you’d be hard pushed to find a fund which has meaningful TAA,” Lambert concludes.