This excerpt, taken from Balentine’s 2020 Capital Markets Forecast, explores why now is an opportune time for global tactical asset allocation strategies. Want to learn more? Don’t miss Balentine’s full 2020 Capital Markets Forecast, our signature research piece that serves as the foundation of our investment process.
Many institutions rely on strategic asset allocation (SAA) to maximize their risk-adjusted returns. However, the inherent long-term focus of many such allocations may cause investors to miss near-term market opportunities. This weakness can be addressed by making a strategic allocation to a global tactical asset allocation (GTAA) strategy. The current environment appears promising for GTAA, which has historically participated in up markets, while protecting investor capital in down markets. These characteristics allow GTAA to address late-market cycle opportunities and risks without the potentially higher costs that come with alternative strategies, such as low-volatility and low-beta.
Global Tactical Asset Allocation (GTAA) is a form of multi-asset class investing. GTAA managers assess a global opportunity set utilizing a fundamental and/or quantitative investment process to identify short-term opportunities across asset classes and/or individual securities. This tactical focus adds value by complementing a plan’s long-term strategic view.
Let’s Not Forget About the Benefits of GTAA
Investors should not make decisions about GTAA on the basis of the last decade, which isn’t typical of how markets behave. GTAA has fallen out of favor during this period of abnormally low volatility, fueled partly by interest rates at historic lows. There have been no bear markets—declines of 20% or more for at least two months—during this decade. December 2018’s sharp decline was the closest thing to a bear market. In contrast, during the previous decade, the bear markets of 2000 and 2008 highlighted GTAA’s risk management abilities. Another unusual characteristic of the past decade has been the sustained gains by a single asset class. During this period, plans that invested heavily in U.S. large cap stocks have racked up sizable gains, while smaller and non-U.S. stocks and more diversified approaches have lagged (Figure 6).
The long, concentrated bull market of the past decade has not been kind to large GTAA managers using complex strategies and relying solely on valuation metrics to make investment decisions. Due to these strategies’ underperformance, plans and their consultants have drifted away from GTAA, not having seen the benefits of risk management since 2009. However, students of the markets know this will not last forever, especially as we see signs that this bull market may be in its final innings.
Additional factors have depressed the reputation of GTAA managers:
Some GTAA managers focus only on valuations to drive their movements in and out of asset classes, putting them on the wrong side of asset class movements over the past decade. We find it more effective to drive allocations with momentum, in addition to valuations.
Some managers take an overly complicated approach to GTAA. For example, they use techniques such as leverage and illiquid assets, which make GTAA difficult and expensive to reproduce on a large scale. These techniques also make it hard for managers and consultants to explain the strategy’s investment process to trustees. It’s no wonder plans have been reluctant to invest in what seems like a “black box.” However, plans may not realize that some managers offer transparent, uncomplicated GTAA strategies at competitive fees.
When GTAA is offered by a firm with mammoth assets under management, the GTAA portfolios tend to look much like a standard, broadly diversified asset allocation. Size seems to sap firms’ ability to invest with high conviction and tactical moves, undercutting GTAA’s purpose and value. As a boutique firm, we can be nimble in navigating investment opportunities.
How GTAA Complements SAA
An institutional plan that relies solely on strategic asset allocation may miss near-term market opportunities. This is because its strategic asset allocations change infrequently, due to three main reasons:
The chain of decision making has multiple links.
Board meetings are infrequent and calendar-based.
Responsibilities other than asset allocation have greater perceived importance to the organization.
Approval of changes to a plan’s strategic asset allocation can take months, or even up to a year to implement.
In contrast, the sole focus of GTAA managers is to identify and act on opportunities. They move quickly to protect capital and to capture market upside opportunistically as market cycles develop. Thus, GTAA managers provide timing diversification to institutional plans.
In addition, GTAA can tilt the portfolio toward asset classes that are outperforming, and away from underperforming asset classes. It can also add allocations to asset classes, such as commodities, to which the institutional plan might not make an independent, strategic allocation. The nimble implementation of these techniques allows GTAA to protect capital in down markets, while still participating in up markets, as we describe in the next section.
GTAA has Outperformed in Bear Markets, Participated in Bull Markets
Before adding a GTAA strategy to a portfolio, investors and consultants should understand how these strategies have historically performed in different market environments. Looking back at the previous two market cycles, GTAA strategies have historically performed best in bear markets, especially in severe bear markets. As Figure 7 shows, GTAA outperformed during the bear markets of the Financial Crisis and the Tech Bubble.
Average GTAA manager excess return was calculated by first taking the average monthly return of managers in the eVestment Global Tactical Asset Allocation universe. After that, the monthly excess returns were calculated using the monthly return of the listed benchmark. The monthly excess returns were then annualized based on the time period.
GTAA strategies’ performance in bull markets is not as strong, as shown by the two most recent bull markets (Figure 8). Their only positive relative performance during the first bull market came versus the most conservative (60% equity/40% fixed income) portfolio. GTAA did not outperform the 60/40 portfolio during the second bull market partly due to its extended length—130 months as of December 2019 versus only 61 months for the first bull market—allowing risk to be taken off the table. In addition, the second bull market has been characterized by low asset class performance dispersion, which has hampered diversification and tactical opportunities.
As mentioned earlier, the low volatility and significant outperformance of one asset class—U.S. large cap growth—has made it difficult for GTAA to outperform in recent years. Given these historical patterns of relative performance, institutional investors may wonder if they should enter GTAA strategies during bear markets and then exit during bull markets (especially a bull market dominated by a single asset class). However, bear markets are notoriously difficult to time. Also, the inherently slow-moving nature of allocation shifts means that by the time a board moves, the biggest opportunities will have passed. In contrast, a GTAA manager can act quickly, which has provided significant value over full market cycles.
Figure 9 illustrates the growth of $1M invested with the average GTAA manager compared to a 60/40, 80/20, and 100% ACWI portfolio. A million dollars invested in the average GTAA manager in March 2000 would have grown to $3.60M by December 2019, a 360% increase. Investing the same amount into a 60/40, 80/20, or 100% MSCI ACWI portfolio would have created an ending value of $2.92M, $2.90M, and $2.82M, respectively. This analysis assumed monthly rebalancing.
The outperformance of the average GTAA manager over an entire market cycle, combined with the inability to properly time bear markets, suggests plans will be best served by sticking with a GTAA manager throughout the market cycle. In fact, as the current bull market sets records for length, and its nature begins to change, now may be a particularly good time to consider a GTAA manager.
Why Now is an Opportune Time for GTAA Strategies
The market environment shows signs that asset class dispersion is increasing—another indicator that we are in the later innings of the current bull market. While diversification has not paid off during this long, grinding up-market, since 2013, the seven-year rolling dispersion numbers have steadily increased (Figure 10).
The results in Figure 10 were calculated by averaging the seven-year return dispersion of the following asset class comparisons: U.S. large cap growth versus U.S. large cap value, U.S. small cap growth versus U.S. small cap value, U.S. large cap versus U.S. small cap, U.S. large cap versus real estate investment trusts (REITs), U.S. large cap versus international developed, and U.S. large cap versus emerging markets.
As demonstrated below, the past decade’s market environment has exhibited abnormally low dispersion of returns between market segments. Low dispersion, combined with historically low interest rates and low volatility, have made it very difficult for GTAA managers to outperform their benchmarks.
Before giving up on GTAA strategies because of their recent performance, investors should consider that we are only halfway through the current market cycle (as measured by a bull market followed by a bear market), and GTAA strategies have historically provided most of their value in the cycle’s second half. Timing the start of a bear market is difficult. However, it’s easy to make a strategic allocation to GTAA to manage the risk of a bear market without fully removing a portfolio from participation in a bull market.
If you are worried about late-cycle risks—and you’d like to take advantage of the late cycle’s opportunities—invest with a GTAA manager. Look for a manager who makes nimble, high-conviction investments within a tight risk budget, and who delivered good performance during the more normal markets of 2000-2009. Look also for one who has successfully weathered the past decade’s unusual markets. Other desirable characteristics include a stable team and an easy-to-understand, repeatable process delivered in a cost-effective, liquid vehicle. Act now to position your plan for market upheaval.