GTAA Delivers Solid Returns at Lower Risk. Period.
Just the Facts, Part 4

We recently came across a couple of articles making the sensational claim that TAA is nothing more than a repackaged and dressed-up version of market timing. Both articles – and others, we’ve subsequently learned – point to a Morningstar study showing that TAA has underperformed the Vanguard U.S. 60/40 balanced fund over the past few years. We have several problems with the original study and the referencing posts, but it all boils down to these points of difference:

  • TAA is still widely misunderstood by many investors and advisors;
  • TAA does not require discretionary market calls, and is best implemented by harnessing timeless and pervasive market factors like value and momentum;
  • It is silly to benchmark most TAA strategies against a domestically focused stock/bond benchmark, such as a balanced fund.

For those who want to read our comprehensive position at GestaltU, the post can be found here.

At the end of the day, however, we understand every aspect of this discussion circles back to one simple concept: performance. When we left off in Part 3 we had established that the most appropriate benchmark for GTAA strategies was the Global Market Portfolio (GMP). To recap, this is because it is passive, it is investible and it reflects the investing opportunity set of the manager. In other words, it is the aggregate portfolio of all global investment managers. Here is what the benchmark has done since 2010:

Figure 1. Performance of the Global Market Portfolio

gtaa 4-1
gtaa 4-2Source: CSI Data

Now that we have specified the most appropriate benchmark, we can get down to the business of evaluating how well GTAA strategies have performed. How should we judge success? We submit that for GTAA strategies in particular we should judge results on both an absolute and a relative basis. When judging absolute results, it is our core belief that there is no way to properly evaluate performance without observing both rewards and risk. It’s like describing all the features of a product without any discussion of the cost.

  • Do I want a private jet so that I can travel whenever and wherever I want without the hassle of airport lineups? Sure. Do I want it for $6 million plus $250k per year in maintenance costs? No.
  • Do I want to invest in a strategy that might make 10% per year? Sure. Do I still want it if the strategy experiences a drawdown of 40% or more about one year in 5? Probably not.

While many managers would debate our preferences, we first look to a strategy’s Sharpe ratio when evaluating GTAA approaches. Many thoughtful consultants and advisors object to the Sharpe ratio because they assert that investors are unconcerned with upside volatility, and focus exclusively on downside risk. While it’s true that the Sharpe ratio does not differentiate between upside and downside volatility, it is important to note that volatility clusters in markets. In other words, the largest down days are often adjacent in time to the largest up days. One needs to only look back to 2008/9 as proof of this. The chart below highlights all the days the S&P 500 either lost or gained more than 3% in a single day since 1990. It is interesting to note that over the last 25 years, the upside volatility tended to cluster during cyclical bear markets. This might come as a surprise to many investors, and as such, we perceive the symmetrical character of volatility as a better way to capture the true risk of a strategy than, say downside deviation.

Figure 2: Volatility Clustering (3% Gain/Loss Days in S&P 500 Since 1990)

gtaa 4-3Source: Morningstar, CSI Data

That said, we are also interested in non-parametric measures or risk such as drawdown and ulcer index, as these capture the true risk of a strategy when markets become non-normal, as they often do during crises, and the linearity of the return experience.

Unfortunately, the Morningstar report we’ve so often referred to does not provide absolute risk information, so on an absolute basis we can only observe the benefits (returns) of the strategies, not the costs (risk). However, we can evaluate the relative performance of GTAA strategies by comparing them to our two benchmarks. Morningstar has also blessed us with relative risk-adjusted metrics, so that we can judge the relative merits of a strategy vis-a-vis the benchmark in terms of both relative benefits (alpha) and costs (beta). We extracted the results of the Global All Assets – Tactical strategies with at least 5 year track records in Figure 3:

Figure 3. GTAA performance vs. appropriate benchmarks

gtaa 4-4Source: Morningstar, CSI Data

A comparison of just the annualized returns for the GTAA strategies relative to the benchmarks shows that they track each other very closely at each horizon, though the average GTAA strategy tracks the GMP more closely than the Morningstar benchmark, especially in 2014. In fact, this is a sign that the benchmarks are well specified. It is also, perhaps, to be expected; the GMP is, after all, the average of all active asset class bets!

On average, the GTAA strategies soundly beat Morningstar’s improper benchmark and even edged out the GMP over the 2014 calendar year, and were even with benchmarks over 3 and 5 year periods. It is interesting to note that while the average GTAA annualized returns appear to track closely to benchmark annualized returns, the Morningstar benchmark explains less than 70% of GTAA returns, as measured by average R-Squared values. We can therefore conclude that, while the benchmark is relatively well specified, GTAA strategies are harvesting returns from sources other than passive global beta exposures.

In other words, their active bets appear to be paying off.

And the story is more interesting once we observe the risk-adjusted characteristics. Note that the GTAA strategies tracked or exceeded their benchmark with less risk, as GTAA betas averaged just 0.8 over the past 5 years. Since GTAA strategies provided similar returns with less systematic risk, they delivered alpha of about 1% per year above their passive, globally diversified benchmark.

The fact is, the past 5 years have been an extraordinary period for global markets, characterized by a massive recovery in global risky assets coincident with a huge compression in global volatility. Many markets have experienced record consecutive periods without the meaningful corrections we typically observe, even during bull market cycles. As a result, GTAA strategies, which are typically constructed to really shine during crises, have yet to see their day in the sun. In fact, I’m mildly surprised to see that GTAA strategies have competed so well during this bull market phase of the cycle.

Which brings us to the real kicker, here: We won’t get to see just how resilient these strategies are until they stand tall above the detritus of the next bear market.

Disclaimer

Confidential and proprietary information. The contents hereof may not be reproduced or disseminated without the express written permission of ReSolve Asset Management Inc. (“ReSolve”). ReSolve is registered as an investment fund manager in Ontario and Newfoundland and Labrador, and as a portfolio manager and exempt market dealer in Ontario, Alberta, British Columbia and Newfoundland and Labrador.
These materials do not purport to be exhaustive and although the particulars contained herein were obtained from sources ReSolve believes are reliable, ReSolve does not guarantee their accuracy or completeness. The contents hereof does not constitute an offer to sell or a solicitation of interest to purchase any securities or investment advisory services in any jurisdiction in which such offer or solicitation is not authorized.

Forward-Looking Information. The contents hereof may contain “forward-looking information” within the meaning of the Securities Act (Ontario) and equivalent legislation in other provinces and territories. Because such forward-looking information involves risks and uncertainties, actual performance results may differ materially from any expectations, projections or predictions made or implicated in such forward-looking information. Prospective investors are therefore cautioned not to place undue reliance on such forward-looking statements. In addition, in considering any prior performance information contained herein, prospective investors should bear in mind that past results are not necessarily indicative of future results, and there can be no assurance that results comparable to those discussed herein will be achieved. The contents hereof speaks as of the date hereof and neither ReSolve nor any affiliate or representative thereof assumes any obligation to provide subsequent revisions or updates to any historical or forward-looking information contained herein to reflect the occurrence of events and/or changes in circumstances after the date hereof.

General information regarding returns. Performance data prior to August, 2015 reflects the performance of accounts managed by Dundee Securities Ltd., which used the same investment decision makers, processes, objectives and strategies as ReSolve has used since it became registered and commenced operations in August, 2015. Records that document and support this past performance are available upon request. Performance is expressed in CAD, net of applicable management fees. Indicated returns of one year or more are annualized. Past performance is not indicative of future performance.

General information regarding the use of benchmarks. The indices listed have been selected for purposes of comparing performance with widely-known, broad-based benchmarks. Performance may or may not correlate to any of these indices and should not be considered as a proxy for any of these indices. The S&P/TSX Composite Index (Net TR) (“S&P TSX TR”) is the headline index and the principal broad market measure for the Canadian equity markets. The Standard & Poor’s 500 Composite Stock Price Index (“S&P 500”) is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy.

General information regarding hypothetical performance and simulated results. These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account or fund managed by ReSolve will or is likely to achieve profits or losses similar to those being shown. The results do not include other costs of managing a portfolio (such as custodial fees, legal, auditing, administrative or other professional fees). The contents hereof has not been reviewed or audited by an independent accountant or other independent testing firm. More detailed information regarding the manner in which the charts were calculated is available on request. Any actual fund or account that ReSolve manages will invest in different economic conditions, during periods with different volatility and in different securities than those incorporated in the hypothetical performance charts shown. There is no representation that any fund or account will perform as the hypothetical or other performance charts indicate.

General information regarding the simulation process. The systematic model used historical price data from Exchange Traded Funds (“ETFs”) representing the underlying asset classes in which it trades. Where ETF data was not available in earlier years, direct market data was used to create the trading signals. The hypothetical results shown are based on extensive models and calculations that are available for any potential investor to review before making a decision to invest.