The case for Global Tactical Asset Allocation

A new breed of Global Tactical

Asset Allocation (GTAA) funds
bring an expanded set of
opportunities to capture extra
return. They offer a flexible,
efficient process that can be
implemented quickly.

UBS, Main Partner of Alinghi, Defender of 32nd America's Cup

Photo: Daniel Forster

For intermediate customers only

The Funds referred to in this document are unregulated collective investment schemes and as such may only be marketed and made available to persons in accordance
with section 3.11 of the FSA's Conduct of Business Sourcebook or the Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions)
Order 2001. Any other person should not rely on this document.
The case for Global Tactical Asset Allocation
Strategic and tactical asset allocation
There are potentially two distinct roles for asset allocation
– strategic and tactical. The strategic asset allocation
determines in which asset classes and in what proportions
the pension fund will invest. It is normally decided by the
pension fund trustees, in consultation with their
consultants. The strategic allocation takes account of the
fund’s liabilities and longer-term return objectives. The
strategic position will be the main determinant of the
fund's return and risk characteristics, in both absolute
terms and relative to the scheme's liabilities.
Another potential role for asset allocation is tactical.
Traditionally, the objective of tactical asset allocation (TAA)
is to add value for the pension fund by moving away from
the strategic asset allocation for periods of time to take
advantage of valuation anomalies across the different asset
classes comprising the strategic benchmark.
The traditional approach to TAA
Traditionally, a multi-asset pension fund would set its
strategic asset allocation in line with a peer group
benchmark that measured the average asset allocation of
sometimes large groups of different pension funds. The
manager of each fund would then use their discretion to
alter the asset class weightings around this benchmark,
within limits defined by the pension fund trustees. This
process is illustrated in Chart 1.
Strategic asset allocation Traditional tactical asset allocation
(Trustee/Consultant) (Fund Manager)
Liabilities Assets Assets Assets
A A expensive
B B cheap
C C cheap
D D expensive
strategic allowed
benchmark ranges
Source: UBS Global Asset Management
Over the past few years, the strategic aspect of asset
allocation has been the focus of a great deal of attention
and discussion as the pension fund community reassessed
prior assumptions. One trend has been a significant shift
away from peer group benchmarks as the basis for
strategic asset allocation. Many pension funds have
decided that their strategic asset allocation should be
more closely matched to their own specific liabilities,
rather than to some average that could be inappropriate.
2
Trends in TAA
These changes in strategic asset allocation have coincided
with, and in some ways encouraged, changes in the tactical
asset allocation process. One trend has been a reduction in
the use of TAA as a source of added value. This partly
reflects a perception that traditional forms of TAA performed
relatively poorly. In addition, there has been an increasing use
of specialist fund managers. As funds have moved to
benchmarks tailored more closely to their specific liabilities,
they have also tended to appoint a specialist fund manager
for each specific asset class which makes traditional forms of
TAA difficult under the conventional approach.
However, ignoring TAA completely removes a potentially
valuable and important additional source of return. Typically,
multi-asset funds that contain a mix of different asset
classes would expect to achieve about a quarter of their
out-performance relative to respective benchmarks from
TAA. TAA can thus be seen as another capability, just like
equities or bonds, which could provide returns with a low
correlation to other elements of the portfolio. This helps to
increase the portfolio's efficiency in terms of the balance
between risk and return. For this reason, new techniques for
implementing TAA have evolved, and have become more
commonly known as Global Tactical Asset Allocation
(GTAA). These allow pension funds to obtain exposure to
TAA, even if they employ specialist fund managers for each
asset class. In addition, these new techniques remove many
of the constraints that traditional methods imposed on TAA,
thereby allowing for higher returns and/or lower risk than
could previously have been expected from this capability.
Benefits of GTAA funds
New approaches to TAA often involve the creation of a
self-contained GTAA fund that can be used to overlay
A
TAA views onto existing portfolios, regardless of their
benchmarks. Typically, the pension fund would make a
small allocation (say 3%) to the GTAA fund. The GTAA
manager can then use derivative products such as equity
B and bond futures, and currency forwards, to achieve an
investment return from TAA that replicates or exceeds the
contribution typically expected from traditional TAA
C
techniques. While the fund manager will still be restricted
by agreed limits on the level of risk that they can take
D within the GTAA product, there are a number of major
advantages from using this type of approach that mean it
is more efficient in terms of risk and return than
traditional TAA methods. For example:
• Unlike traditional TAA, these GTAA funds can take
views on asset classes that lie outside the strategic asset
allocation or benchmark. This creates a much larger
range of investment opportunities. In addition, currency
views can be separated from views on other assets.
• Using derivatives means that it is possible to "short" an
asset class. That means that if the fund manager thinks
an asset will fall in value they can effectively sell that
asset and will then gain if its price falls. This is
impossible using traditional techniques, since the fund
 manager can only invest in a physical asset, so cannot
own less than none of it.
• Investing in physical assets can make it difficult to
express asset allocation views. For example, a fund
manager may decide that bonds in a particular country
are cheap, but that the currency of that country is
expensive. This creates a dilemma, and the net result
may be that no view is taken. Using derivatives it is
possible to separate these two decisions – buying the
bonds and selling the currency, creating a much wider
range of potential investments.
• Using derivatives avoids any disruption to underlying
portfolios of stocks or bonds.
The common theme is that newer GTAA techniques tend
to remove constraints on the TAA process that have, in the
past, restricted the range of investment opportunities
available. Removing these restrictions tends to result in a
more efficient portfolio, and therefore an improvement in
the risk-return trade off to the benefit of the pension fund.
Introducing MARS and CARS
We have established a package of GTAA funds called
MARS (Market Absolute Return Strategy) and CARS
(Currency Absolute Return Strategy) which together
deliver a GTAA overlay strategy. This package builds upon
our 20 years of experience in adding value from asset
allocation, as shown in Chart 2. MARS and CARS are
managed by our Asset Allocation and Currency team,
part of our Global Investment Solutions area.
Asset allocation (inc. currency) contribution for a
typical multi-asset fund for a UK client
Period to 30 Sept 2006 % p.a. value added
1 year -0.03
3 years 0.28
5 years 0.49
10 years 0.41
15 years 0.31
Since inception (Dec 1985) 0.33
Source: UBS Global Asset Management
How do MARS and CARS work?
MARS
The purpose of MARS is to take tactical asset allocation
positions in different asset markets. These positions are
implemented using derivative products to gain exposure
to a range of different asset classes, including global
equity and bond markets, through the use of futures and
other derivative products. The benchmark for the fund is
the risk-free rate of return i.e. the short-term cash rate.
The use of derivative products means that the fund can
take short positions in an asset class if it is expected to
fall in value. In addition, it is possible to separate the view
on an asset class from the view on the currency in which
it happens to be denominated. These attributes mean
that the MARS fund seeks to achieve a relatively efficient
expression of tactical asset allocation views. The fund can
be leveraged, although it will not borrow to invest, and
operates within strict limits regarding leverage.
The portfolio is managed on a price/intrinsic value basis
with integrated risk control. Besides our valuation models,
which provide us with estimates of future returns, we
attach great importance to risk management. We have
developed proprietary risk management systems, which
support our portfolio construction process at every level.
CARS
The purpose of CARS is to apply currency strategy as an
overlay to a client portfolio independently of asset
allocation or benchmark. These positions are
implemented using derivative products linked to exchange
rates. Such derivatives are typically highly liquid interbank
forward contracts. The forward currency market is the
world’s deepest and most liquid market. CARS also has
the flexibility to use currency options. The benchmark for
CARS is the risk-free rate of return.
As with MARS, the advantage of using derivatives
compared to shifting cash or other assets between
currencies is that CARS can gain desired currency
exposures without the need to adjust the physical assets
in the portfolio, resulting in greater efficiency in the
expression of currency investment views. CARS can be
leveraged, but does not borrow to invest, and operates
within strict limits regarding leverage.
Currencies are managed on a price/intrinsic value basis
using our valuation model and its forward-looking capital
market assumptions, coupled with our risk management
capability. The objective is to achieve returns that
positively compensate for the desired level of risk taken.
Opportunities to add value arise primarily when market
behaviour causes currencies to deviate from fair value
such that the price/value discrepancies can be recognised
and exploited.
GTAA and the risk budget
This GTAA package has high levels of risk and leverage,
but these should be seen in the context of the total fund
assets. For example, assume a multi-asset fund has
invested 3% of its total assets (2% in MARS and 1% in
CARS). The resulting typical 25.3% risk of a stand-alone
investment translates into 0.76% risk at the total fund
level. This level of risk is actually relatively low compared
to most standard multi-asset funds. Likewise, a typical
17% return in this package translates into a 0.51%
return contribution to a standard multi-asset fund. Of
course, if less than 3% of total assets are invested,then
risk and return would be lower, and vice versa.
3
 For a multi-asset portfolio, investment in MARS and CARS
Typical risk Stand-alone Within portfolio1 would normally be funded out of the allocation to bonds.
MARS 30% 0.60%
To replace this exposure, we also offer GEF (Gilt Exposure
Fund) as part of our GTAA package.
CARS 30% 0.30%

Combination2 25.3% 0.76% In summary

• GTAA involves implementing asset allocation strategies
Typical return 3
Stand-alone Within portfolio1 using derivative instruments to obtain the appropriate
exposures without needing to buy and sell physical
MARS 18% 0.36% assets.
CARS 15% 0.15% • Our GTAA fund package (MARS and CARS) offers an
2
expanded set of opportunities and increased flexibility
Combination 17% 0.51%
and efficiency.
1 Based on 2% MARS, 1% CARS allocation from a multi-asset portfolio
• The package offers clients improved accountability,
2 Based on 2:1 relative allocation to MARS vs CARS
transparency and attribution reporting.
3 Average annualised return over a full market cycle
Source: UBS Global Asset Management • GTAA funds are high risk vehicles and are intended for
use as an overlay strategy by committing a small
portion of the total portfolio.

For intermediate customers only.

The Funds are offered by UBS (Irl) Professional Investors Funds 1 plc (The
"Company") and marketed by UBS Global Asset Management (UK) Ltd. This
document gives an overview of the Funds but does not replace the formal fund
prospectuses, which are available on request. The value of investments and the
income from them may go down as well as up and are not guaranteed. You may
not get back the amount invested. Changes in rates of exchange may cause the
value of this investment to fluctuate. The Funds may enter into swaps, which can
carry a higher risk than investment in assets directly. Investments in emerging
markets carry more risk than investments in developed markets. The Funds may
utilise such investment techniques as option transactions, margin transactions,
short sales and futures and forward contracts. However, such investments are
inherently volatile and the Funds could be potentially exposed to additional risk
UBS Global Asset Management (UK) Ltd and cost should the market move against it.
21 Lombard Street The protections provided by the UK regulatory system, and compensation under
London EC3V 9AH the UK's Financial Services Compensation Scheme, will not be available. Issued by
UBS Global Asset Management (UK) Ltd, a subsidiary of UBS AG. Authorised and
Tel. +44-(0)20-7901 5000 regulated by the Financial Services Authority: UBS Global Asset Management (UK)
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www.ubs.com December 2006

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