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In an environment of low yields, lower-than-average expected returns, rising volatility and increasing correlations between asset classes, investors are increasingly looking to diversify their portfolio away from their traditional equity and bond beta exposures. Alternative strategies are designed to provide these differentiated sources of return.
Over the years, alternative strategies have found their way into the portfolios of a broad investor audience. Traditionally, hedge funds were the only vehicles to provide access to these alternative strategies. But the recent emergence of ‘liquid alternatives’ has made alternative strategies available for investors in a more transparent and cost-efficient way. Although hedge funds and liquid alternatives both aim to provide portfolio diversification, notable differences remain. Robeco Global Tactical Asset Allocation (GTAA) is an example of a liquid alternative strategy. In this newsflash we will compare GTAA with a popular hedge fund style: Commodity Trading Advisor (CTA) strategies. We first highlight the main differences in approach between GTAA and CTA strategies. Next we compare the return profiles of the two. Finally we illustrate how both can add value in a portfolio context.
GTAA is a multi-asset absolute return strategy that shares several characteristics with CTA strategies. First, GTAA is a fully systematic strategy, just like most CTA strategies. Second, both GTAA and CTAs are applied in a multi-asset universe and exploit the directionality of asset classes by taking long and short positions. Third, trend is an im-portant factor in both GTAA and CTA strategies. Trend factors have the attractive characteristic to provide protec-tion, and even profit, in falling markets. Thanks to this feature the correlation with equities and bonds is generally low for both approaches.
On the other hand, there are clearly a number of differences between GTAA and CTA strategies. The main differ-ence is that GTAA pursues a multi-factor approach, while most CTA’s are dominated by a single theme, i.e. trend. In the design of GTAA we recognize that trend is an important predictive factor, but we do not believe that trend is a superior factor that makes other factors redundant. In GTAA we leave room for factors other than trend that can drive asset returns, such as the valuation among asset classes and market sentiment. Each factor in GTAA is based on sound economic and behavioral rationales, while CTA strategies generally only focus on identifying price pat-terns. Other differences with CTA strategies relate to the transparency and liquidity of the strategies. GTAA can be classified as a liquid alternative strategy, while most CTAs are available in hedge fund format only. GTAA is a UCITS-compliant strategy with a portfolio that is characterized by a transparent set of positions. By only investing in the most liquid instruments, GTAA is able to offers daily liquidity to clients. In contrast, a typical CTA portfolio consists of hundreds of (levered) positions, the investment process is often a black box, and liquidity is usually only available on a monthly or quarterly basis. Besides, most CTA strategies are not available in UCITS format. As CTAs usually invest a significant part of their portfolio (both long and short) in individual commodities, it is very challenging for CTAs to offer their strategy in a UCITS-compliant vehicle, without sacrificing on their investment process.
Next we compare the return profiles of GTAA with that of a CTA index. CTAs tend to have attractive long-term re-turn characteristics. However, over shorter periods, returns can be lagging if the environment is not beneficial for a trend-following strategy. We use the Barclay CTA index as a reference. This is a non-investable index that measures the composite performance of established CTA programs that have a performance history of at least four years. It is widely recognized as a leading index for CTA strategies.
Over the period May 2010 (the inception date of GTAA) until December 2015, both GTAA and the CTA index deliv-ered positive returns. GTAA gained 9.58% with a Sharpe ratio of 0.74, while the CTA index increased by 2.02% with a Sharpe ratio of 0.33. The volatility of GTAA (12.96%) over the period was roughly twice as large as the volatility of the CTA index (6.20%). The correlation between GTAA and the CTA index was 53%. This positive correlation can be explained by the shared inclusion of a trend factor in both strategies. However, if we take a close look at the re-turns through time, then we clearly observe the advantage of a multi-factor approach over a single-factor ap-proach. In particular at times when trend was not able to deliver meaningful positive returns (roughly from mid-2010 until mid-2014), GTAA profited from the inclusion of other investment themes, such as macroeconomic mo-mentum, valuation and sentiment.
Source: Robeco, Bloomberg. Data period: May 2010 – December 2015, monthly observations. GTAA return is based on NAV of I-share class (EUR), CTA Index return is based on the Barclay CTA index. Traditional Balanced is 50% MSCI World + 50% Barclays Global Aggregate. Traditional balanced + CTA is 40% MSCI World + 40% Barclays Global Aggregate + 20% Barclay CTA Index. Traditional balanced + CTA + GTAA is 40% MSCI World + 40% Barclays Global Aggregate + 10% Barclay CTA Index + 10% GTAA. The value of your investments may fluctuate. Results obtained in the past are no guarantee of future returns.
Next we evaluate how GTAA and CTAs can add value in a balanced portfolio context. The main reason for investors to consider GTAA, CTAs or other alternative strategies in their portfolio is usually the diversification potential. As a starting point for our analysis we consider a simplified traditional balanced portfolio that allocates equally to global equities and bonds. Over the period May 2010 - December 2015 this portfolio profited from rising equity markets and falling bond yields and delivered an attractive Sharpe ratio of 1.28. Next we consider a portfolio that allocates 20% to CTAs, at the expense of the equity and bond allocation. This portfolio has a lower return (7.73%)
than the original balanced portfolio (9.15%), which can be explained by the notion that CTAs had a difficult time during this period, while equities and bonds produced strong returns. From a risk perspective, the allocation to CTAs reduces the overall volatility of the portfolio, which results in a Sharpe ratio of 1.23, which is slightly lower than the original portfolio. Finally, we consider a portfolio that splits the 20% allocation to alternatives equally into GTAA and CTAs. Although the correlation between GTAA and CTAs has been positive, and GTAA has a higher volatil-ity than the CTA index, the volatility of this portfolio is comparable to that of the portfolio that only invests in CTAs in the alternative bucket. At the same time, the portfolio profits from the attractive return from GTAA. Overall, this portfolio delivers the highest Sharpe ratio (1.32) of all portfolios considered.
In this newsflash we compare Robeco GTAA with CTA strategies. There are several similarities, such as the systematic character and the inclusion of trend as an important factor in the investment process. However, there are also notable differences. While many CTA strategies are pure trend-following, GTAA is a multi-factor approach and therefore not dependent on a single factor. GTAA can be classified as a UCITS-compliant liquid alternative. On the other hand, most CTA strategies are only available in hedge fund format, which means they are generally less transparent, less liquid and more expensive.
In a portfolio context, both GTAA and CTA strategies aim to diversify the portfolio and provide more stable portfolio returns. Because GTAA has a different return profile than CTAs, GTAA can have added value in a portfolio. An investor who invests in CTAs as part of the alternatives allocation in a balanced portfolio can improve his or her Sharpe ratio by spreading the alternative allocation between CTAs and GTAA.