What’s in a Label?
The age-old process of labeling can be traced to our early ancestors when labels were a mechanism of survival. Early men and women had to be quick to assess if something was helpful or harmful. In contrast with survival purposes of the past, the investment management industry uses labels for allocators to correctly assign all managers into well-defined style boxes, buckets, and labels (e.g., large-cap growth, investment grade corporate bond, value-add real estate). These labels provide a mutual understanding that managers will stay in their lanes.
Global Asset Allocation: A Solution for the “Labeling Problem”
How does an allocator take advantage of the inevitable opportunities market volatility presents given that the target percentages in each bucket are governed by a strategic asset allocation? Standard rebalancing among different styles will usually not accomplish this because the rebalancing occurs in one of two ways: based upon the calendar or based upon tolerance limits. In the case of the calendar, this means convening the board or the investment committee at some regular interval, which may not conveniently line up with the market opportunity. In the case of tolerance limits, there is very little analysis put into the strength of trends in performance among asset classes, which can lead to allocating money too early or staying in underperforming asset classes. As a result, there needs to be a timely and intelligent process for rebalancing, for which Global Asset Allocation (GAA) offers the solution.
The investor has the option is to hire a manager that can be opportunistic, one not constrained to a specific bucket. Global Asset Allocation (GAA) managers provide such an option by spanning buckets, constantly on the lookout to make tactical shifts in asset allocation as opportunities arise. This allows the allocator to be strategic, while knowing that a portion of their asset allocation will be tactical as market volatility presents opportunities.
Flavors of GAA
GAA as an asset class is the global search for return without the constraints of labels. Some managers are “benchmark free” and look to deliver a CPI+X% return, while others hold themselves to well-known diversified benchmarks, like the 60% MSCI ACWI / 40% U.S. Aggregate Bond Index; Balentine is the latter.
While some consultants and allocators have a designated GAA bucket, most do not, and are left wondering where to put a manager such as Balentine. Below we provide two potential “labels” to use for a GAA allocation.
Use GAA as a “Liquid Alternative”
As traditionally defined, “alternatives” consist of non-stock and non-bond investments or publicly traded investments absent a long-only constraint. These investments have a generally accepted goal of producing absolute returns in all market environments or providing diversification for the stock/bond allocation with an intent to manage risk. For alternative strategies that attempt to drive diversification benefits, the results typically come with liquidity constraints due to lack of marketability, an intentional drive to minimize investment turnover, or vehicle lock-ups.
With a focus on diversification, implementing alternatives as defined above ignores the fact that stocks and bonds are, in general, already negatively correlated with each other. Moreover, for alternatives to be completely decoupled from stocks, they are likely to be more correlated with bonds. Empirical evidence shows that similar diversification results can be achieved through tactical reallocations between stock beta and bond beta, as appropriate, during rising and falling markets. Said another way, the ability to generate alpha via rebalancing betas can achieve the same diversification as traditional alternatives at lower costs and with more favorable liquidity, while also achieving excess return.
Use GAA as an “Opportunistic Fund”
For non-traditional stock/bond managers that are not hedge funds, enter the Opportunistic bucket. This tends to be a catch-all for managers that add value differently than traditional buy-and-hold strategies. Distinct from the risk management benefits of diversification, this category seeks diversification for the purposes of generating alpha which is distinct from diversification for risk management/mitigation. There are a couple ways this approach is employed:
- To garner exposure to asset classes outside of a plan’s strategic asset allocation. In this vein, a GAA manager has the ability to allocate to emerging asset classes that may not have been included in the plan’s SAA, but are ripe for potential excess returns.
- Emphasize asset classes within the plan’s SAA that perform well (and vice versa). Strategic allocations tend to be slow moving, taking advantage of multi-year trends. A GAA manager that exploits trends over the course of months instead of years can complement the strategic allocation. This allows a plan to reach further into the equity universe than the SAA plan alone can offer or, conversely, allocate to bonds at the outset of a structural trend reversal.
Separating tactical managers into a separate asset class more readily enables the allocator to discern if the strategy is meeting the minimum value proposition.
The benchmark for this allocation tends to be the plan’s overall strategic benchmark, and any mandate put here would work to add return or reduce the risk of the overall plan.
How to Source and Benchmark an Allocation to GAA Strategies
Asset allocation is a zero-sum game. Every strategy in a portfolio must be sourced from another strategy, whether it be cash, equities, bonds, alternatives, etc. The decision on how to fund a GAA allocation is primarily a function of the goal of the strategy. For example, an allocator could ask if the intent is to match the equity portfolio over a full cycle with lower volatility, or is it to outperform the broad portfolio benchmark. In the first example, it would make sense to fund the allocation pro-rata from the equity asset classes, while the latter example would argue for funding pro-rata across the portfolio.
Typically, GAA strategies are held accountable against either the plan’s benchmark or a specific stock/bond split akin to the strategy’s strategic allocation. As an example, a plan that has a strategic allocation of 50% stocks and 50% bonds could hire a GAA manager with the same benchmark and then reallocate to 45% stocks, 45% bonds, and 10% GAA in an Opportunistic Fund. The GAA manager would already be aligned with the plan’s benchmark. Conceptually, the source of funds is the opportunity cost.
As with any asset class, there are periods of time when it may fall out of favor and struggle to keep pace with broader benchmarks simply due to beta. For this reason, we advocate using the peer group as a secondary benchmark. This two-pronged approach should provide a foundation to judge the asset class and the manager reasonably.
Regardless of where it is located, a concern that allocators and consultants may share is the inability to control the total allocation to equities at any given time, and how it will impact the plan’s allocation. This can be an issue if plans have strict equity limits written into their investment policy statement, but can be resolved in at least two ways:
- Include the GAA strategy in the equity bucket and size it around the upper bound of the strategy’s equity limit.
- Mandate the maximum allocation to equities for the GAA manager.
In its most conservative form, the first alternative assumes the GAA strategy is at a full equity allocation all the time. While this will limit the potential to violate the plan’s total equity allocation, it comes at the cost of under-allocating to a strategy when equities are not at the maximum allocation and, therefore, limits the risk management capacity.
The second alternative is perhaps a superior approach because it creates better alignment with the purpose of including the GAA strategy in the portfolio, and it does not assume an artificial equity allocation all the time.
As a final consideration, some may be concerned that a GAA strategy may own asset classes that are beyond the scope of the mandate or are expressly prohibited by the plan’s investment policy statement. While due diligence can go a long way toward fully understanding any strategy’s permitted guidelines, there is a better option. By utilizing a separately managed account (SMA), the plan can be assured that the strategy is tailored to its specific code. While mutual funds and commingled vehicles offer some execution convenience, the one-size-fits-all approach can preclude an allocator from investing in the strategy due to the uncertainty of future permissible investments. A secondary benefit of using an SMA instead of a fund is that it provides a much better way to manage the maximum equity dilemma by giving more control to the allocator.
Conclusion: GAA Strengthens Labeling
While the human instinct to label things is likely here to stay, it is important that our industry not be so rote in this exercise as to exclude mandates like GAA. If we instead see the lack of its label as its strength, it can be a useful tool in the allocator’s and consultant’s toolbox, playing multiple roles across different plans.
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