Tactical asset allocation managers have been pummeled by the U.S. stock market, with TAA underweightings to U.S. equities leading to significant underperformance.
The valuation methods employed by TAA managers have led to as low as zero allocations to the U.S. markets.
As a result, TAA managers lagged their benchmarks by 300 basis points in the first half of the year, according to consultant Frank Russell Co., Tacoma, Wash.
Information compiled by another consulting firm, DeMarche Associates Inc., Overland Park, Kan., also shows TAA managers lagging their benchmarks this year, by about 200 basis points.
Global TAA managers may be trailing as well, but because that investment style varies so widely, making generalizations about the managers is difficult, said Jim Thames, senior research analyst with Frank Russell.
Global or domestic TAA managers that have had underweighted allocations to the U.S. stock market - and therefore, presumably, poor returns - include: PanAgora Asset Management, Boston; First Quadrant Corp., Pasadena, Calif.; Brinson Partners Inc., Chicago; and J.P. Morgan Investment Management Inc., New York.
Two managers that have kept their U.S. allocations relatively high, and have outperformed their benchmarks, are Mellon Capital Management Corp., San Francisco, and Analytic TSA Global Asset Management Inc., Los Angeles.
But the investment style's general underperformance hasn't led to a client exodus, because that already occurred.
Many institutions dumped their tactical asset allocators in 1995, "a real ugly year for TAA," when managers lagged by 500 to 600 basis points, Mr. Thames said. This year's underperformance follows relative outperformance in 1996, when TAA managers added value of about 150 to 200 basis points, according to Russell.
Using TAA can fulfill a psychological need in some clients: Plan sponsors are nervous about the market, but don't necessarily want to be the ones pulling the trigger on getting out of stocks, Mr. Thames said. Hiring a TAA manager passes that decision to someone else, he said.
In the meantime, searches for TAA managers have dried up, despite some increased inquiries. The strategy originally gained favor following its strong performance during the 1987 stock market crash.
The view on TAA could turn positive again, if the stock market does correct sharply, Mr. Thames added.
Performance has been lagging significantly for TAA managers that have been out of the market. Edgar Peters, director-asset allocation, for PanAgora, which has been at a zero allocation to the U.S. market at times this year, said the firm's TAA strategy has underperformed its benchmarks by about 600 basis points this year.
He said clients, for the most part, are taking that in stride. "Virtually everybody is comfortable with what we're doing. There haven't been any real problems," he said.
Part of the reason is that PanAgora's strategy is to reduce market exposure when risk is greater than normal. Increased risk doesn't mean there necessarily will be a downturn in the market, only that it's more likely, he said. "In many ways, you'd want us to be wrong," because the client is making a lot of money on the rest of its assets.
Model shows excessive risk
Mr. Peters said PanAgora's model still indicates there's excessive risk in U.S. stocks. An example of that occurred Oct. 3, when news that a U.S. warship was skipping a stopover en route to the Middle East was enough to quickly deflate the Dow Jones industrial average by more than 180 points.
"That sort of shows you what the risks are. What would happen if something serious happened in the Mideast?" he said.
At current levels, market participants are pricing stocks for only "the most optimistic scenarios," he said.
After moving completely out of stocks for a while, PanAgora recently moved some money back into the market. PanAgora's current allocation is 20% stocks, 50% bonds and 30% cash.
That could change quickly, though, because the move was caused by short-term factors, like volatility.
Industry professionals said J.P. Morgan also has been out of the market. Executives there wouldn't comment, a spokeswoman said. Performance numbers in Pensions & Investments Performance Evaluation Report indicate J.P. Morgan's TAA portfolios have been out of stocks.
The firm's TAA separate account composite returned 13.5% in the year ended June 30.
For the same period, an allocation of 60% to the Standard & Poor's 500 Index and 40% to the Lehman Brothers Government Corporate Index returned 23.9%
First Quadrant's domestic and global TAA products have been underweighted in U.S. stocks this year. First Quadrant overweighted U.S. stocks in the first quarter, and underweighted in the second and third quarters, said Robert Arnott, president and chief executive.
As a result, the strategy is behind benchmarks by about 300 basis points - "not a terrible hit, but still disappointing," Mr. Arnott said.
"My feeling is that TAA is not intended to pick tops and bottoms," he said. To do so, would be "misguided and inappropriate," he said. TAA gauges the long-term attractiveness of markets, and First Quadrant's model shows an expected return from U.S. stocks of 6.5% to 8% at the most optimistic, which compared with a long-term bond yield of 6% is not that attractive.
Currently, the portfolios are weighted 30% stocks, 40% bonds and 30% cash.
Globally, First Quadrant's GTAA was hit by a double whammy of being underweighted in U.S. stocks and overweighted in Japanese stocks. Performance, behind benchmarks by about 200 basis points, would have been worse if First Quadrant's GTAA portfolios had not been overweighted in global equities overall, Mr. Arnott said.
Executives for Brinson Partners were unavailable for comment. They, too, were cited by industry participants as being out of the U.S. stock market in their TAA accounts.
An executive for a Brinson pension fund client, who spoke on the condition of not being named, said Brinson's global TAA allocation has a zero allocation to the U.S. stock market, and is several hundred basis points behind its benchmark because of that.
Brinson was severely underweighted to U.S. stocks as far back as a year ago. Gary Brinson, president, noted last October that the firm's GTAA portfolio for the Teachers' Retirement System of Illinois, Springfield, was 26% allocated to U.S. stocks, using a benchmark of 50% stocks. Brinson was 36.5% weighted to U.S. dollar bonds, with a benchmark of 25%, and 25% weighted to non-U.S. dollar bonds, with a benchmark of 10%. Brinson had nothing in cash, matching the benchmark.
Some of the TAA managers that have remained in stocks have been rewarded with outperformance.
Analytic TSA's domestic TAA accounts have returned about 300 basis points above its benchmarks this year. Its TAA model has aggressively weighted portfolios in U.S. stocks, and currently is 95% to 100% allocated there, said Harindra de Silva, managing director.
While the current valuations of stocks is a huge negative in Analytic TSA's model, that negative is more than offset by low expected inflation in the United States and strong corporate earnings, Mr. de Silva said.
He said taking such a strong position is tough: "Clients say: 'you'd better be right.' "
He noted the firm's current stance contrasts sharply to 1987 before the crash, when its accounts were completely out of the market.
Mellon Capital is ahead of its benchmarks by 100 to 200 basis points this year, said Polly Shouse, executive vice president in Houston.
She said one reason Mellon has been more in equities than other TAA managers is its use of earnings revision in its investment models. Earnings have been revised upward over time, a positive for the stock market, while fixed-income yields have been down, she said.
