“By using derivatives, the cost of GTAA is around 80 per cent of the expense of allocating and trading across real assets,” she says. “These instruments enable GTAA managers to diversify risk across more assets. For example, we can use derivatives on 23 equity markets, 11 currencies and eight bond markets.”
GTAA is implemented in two ways: through a portfolio overlay or funds. However, whichever method is chosen, the approach is virtually the same, says Ms Minio-Paluello. The manager will analyse the asset allocation and risk profile of the existing holdings in the pension fund. This will influence the approach of the GTAA manager. But the GTAA portfolio is managed separately and will invest in those assets that best suit the risk return profile requested by the trustees, she says.
Some trustees will specify assets that they do not want GTAA managers to hold. But all managers say that the fewer constraints they face, the more effective TAA will be. Ms Minio-Paluello says that one attraction of GTAA is its lack of correlation with the equity and bond portions of the pension fund.
“The GTAA mandates awarded by pension funds have specific return targets for the amount of risk that trustees want managers to take,” she says. “The amount of capital that needs to be allocated to GTAA will depend on these targets but it is typically around 5 per cent of the pension funds’ assets. This is so low because GTAA uses derivatives and can buy on margin.”
In most cases, she says, trustees have adopted GTAA to generate alpha for their portfolios. “Out of 12 GTAA accounts we have won in the UK, only one has used it to help with rebalancing the pension fund as well as alpha generation.”
Dutch demand is high
The greatest demand for GTAA in Europe has come from Dutch pension funds, according to Ms Minio-Paluello. “This is because they are more comfortable with the use of derivatives. There has been growing interest from Scandinavia, notably Sweden. We are hopeful about the growth in demand from Germany because pension funds are facing the same issues as in the UK and elsewhere in Europe but there have been restrictions on the use of derivatives. But this is changing.”
Demand for GTAA has not been confined to £1bn-plus pension funds, she says. “Pension funds of £50m to £100m have used GTAA. The concept works whatever the size of the pension fund and it is still cost-effective for these schemes.”
Jean-Francois Pincon, head of international client development at Credit Agricole Asset Management, says there are three reasons for the growth in the number of formal GTAA mandates in the past couple of years. “It is a logical development following the move to specialised mandates and using a core and satellite approach in pension funds. Second, trustees are realising that rebalancing a portfolio is inefficient. This is because pension funds are selling and buying assets at the wrong time simply to rebalance a portfolio. Third, trustees are seeking ways of adding alpha to portfolios.”
Mr Pincon says the trend among pension schemes in Europe is to use funds for GTAA rather than an overlay on the portfolio. This is partly because the fund approach is an easier concept for trustees to understand. He suggests that, ideally, all of a pension fund’s assets should be held by one custodian for the overlay approach. The growth in demand for GTAA has been partly attributed to the proliferation of funds in the UK market in the past couple of years.
Mr Pincon agrees that the Netherlands is the largest market in Europe and the take up among the Nordic countries has been mixed. “GTAA tends to be confined to the larger pension funds but there are exemptions. The AP2 pension fund in Sweden, for example, has moved away from specialist managers back to balanced mandates.”
Complicated mechanics
Robert Brown, a partner at Watson Wyatt, says the problem with GTAA is that the concept may be relatively straightforward but the mechanics are quite complicated to understand and can use up a lot of the risk budget for trustees. “GTAA is relatively complicated because there are more moving parts. These include the use of derivatives and hedging techniques.”
Robert Brown, Watson Wyatt
He likens GTAA to macro hedge fund managers. “Pension funds can seek managers to take advantage of what they identify as short-term over[valued] and undervalued markets anywhere in the world. The fund manager, for example, may want to go long US equities, short Japanese equities and short French bonds. Generally, the less constrained that the mandate is, the better the results should be. This is because it gives the fund managers freedom to demonstrate their skills in identifying undervalued parts of the market and asset classes.”
Given the relative complexity of GTAA, Mr Brown is cautious about pension funds’ take up of it. “More pension funds in continental Europe have given GTAA mandates than in the UK and it is generally confined to larger pension funds.”
Longer-term view
Euan Munroe, head of strategic solutions at Standard Life Investments, says the firm wants to launch a GTAA product. But he argues that trustees should also allow fund managers to take a longer-term view by making strategic asset allocation calls as well.
“This is an important area for fund managers to add value. The typical balanced fund manager probably adds between 20 and 40 basis points (bp) through stock selection,” says Mr Munroe. “Some should also add outperformance by asset allocation. But this should be split into tactical and strategic asset allocation.
“The issue for trustees is how much risk they are prepared to allow managers to take and how long they are prepared to give their strategic asset allocation calls. For example, when US bond yields fell to 3.6 per cent, we took a medium-term view that capital values will fall.” But such an allocation may require a longer-term view than could be taken by a GTAA mandate, he says. The tactical and strategic asset allocation strategies are different disciplines and may require separate fund managers to run the mandates.
PME’s approach to GTAA
Roland van den Brink, managing director of investments at PME, the €16bn pension fund for Dutch metalworkers, appointed Goldman Sachs Asset Management (GSAM) to manage a GTAA mandate in June 2003. PME subsequently granted a GTAA mandate to Bridgewater, leading Mr van den Brink to say that GTAA does generate alpha for pension fund portfolios.
Roland van den Brink: there is no standard time horizon
“GTAA has been used by Dutch pension funds for many years,” says Mr van den Brink. “I remember chairing a conference on this subject in 1995 that was attended by more than 100 delegates. Many pension funds in the Netherlands have adopted GTAA.”
Before granting the mandate to GSAM, the pension fund had been conducting its own global GTAA strategy, says Mr van den Brink. “We appointed GSAM because the firm complemented our approach to GTAA. Our team makes asset allocation decisions more on the basis of intuition but GSAM uses a quantitatively-based system, so the two approaches provide risk diversification. For the GSAM mandate, it uses 30 derivatives worldwide. We also gave it a mandate to run GTAA using 50 currencies.”
The aim of the GTAA strategies managed by GSAM, Bridgewater and PME is to provide an extra return between them of 40bp after costs, says Mr van den Brink. “Last year, the GTAA strategies generated the extra 40bp of returns.” GSAM and Bridgewater use overlay strategies for the GTAA. “They have to use derivatives because otherwise it is not a cost-effective strategy.”
According to Mr van den Brink, one area of GTAA over which there is no agreement is the time horizon that constitutes tactical asset allocation. “Some pension funds view tactical as up to six months while others say three months. There is no standard time horizon.”
