Why every institutional investor should use a TAA implementation
At State Street Investment Management, we believe global capital markets can be inefficient in the short run — driven by behavioral biases, market frictions, and fluctuations in risk aversion. Incorporating tactical asset allocation (TAA) can be a way to exploit these inefficiencies and provide the potential for an uncorrelated source of excess return, while helping to manage risk.
Our tactical asset allocation investment process seeks to exploit two related but different categories of investment opportunities — directional and relative value. In the directional category, we evaluate broad asset class comparisons, (i.e., global equities vs core bonds), while in the relative value category we examine intra-asset class opportunities, (i.e., country, region or sector within equities and interest rates versus credit within fixed income).
When evaluating the broad asset class or directional opportunities, we think it is critical to be mindful of investor attitudes toward risk. Determining the level of risk appetite present in the markets helps us understand investor attitudes towards risk assets. State Street Global Advisors’ Market Regime Indicator (MRI) is a dynamic model that incorporates a variety of indicators such as credit spreads, implied volatility, equity market trends, economic growth indicators, Fed balance sheet among others to evaluate investor risk sentiment and identify investors’ risk aversion levels.
In addition to our market regime indicator model, we employ a quantitative framework to evaluate the relative attractiveness of various assets and form total return forecasts. We use these models to help identify both directional and relative value investment opportunities. Our proprietary models employ a multi-factor approach to sift through large quantities of data and evaluate the attractiveness of investment opportunities through a fundamental lens.
Tactical asset allocation can be an effective way to exploit asset-class level inefficiencies to generate diversified source of excess return and help to manage risk.