How active are your clients' multi-asset managers?
Multi-asset investment has become more popular over the past decade, as advisers seek diversification for their clients' portfolios across asset classes and geographies.
After the financial crisis, investors have been more determined to find assets which will not be highly correlated, while making sure portfolios can respond more quickly to significant events, such as political uncertainty and economic downturns.
The age of set and forget - whereby an adviser would simply choose a standard portfolio of diversified assets and leave it to do its own thing - is over, as investors demand better, more active management from their discretionary fund managers, investment houses, and their advisers.
But how active are multi-asset managers and what should advisers be looking out for when it comes to monitoring those who are monitoring the clients' portfolio?
By reading this report, you will understand how to assess various multi-asset strategies and whether they are active enough, analyse how portfolios should be created and comprehend what a 'good' diversification strategy should look like for your clients' multi-asset portfolio.
This report qualifies for 30 minutes of structured CPD.
How active are multi-asset fund managers - and does it matter?
For investment advisers, the list of potential woes never seems to end.
Regulatory scrutiny, downside risk in markets, suitability concerns and an increased focus on cost are currently just a few of the things likely to induce a sleepless night or two.
But this vexatious list is unlikely to include a lack of choice, because in recent years advisers have had a growing selection of investments that may suit their customers’ needs.
Funds have aggressively proliferated, with thousands now available and the ranks still swelling with new entrants. According to figures from Thomson Reuters Lipper, 138 UK-domiciled funds launched just last year.
At the same time, the range of holdings such funds can potentially invest in has expanded, as asset classes which were previously viewed as the preserve of institutional investors, or altogether nonexistent a few years ago, have emerged in the retail space.
These two trends are most obvious in the multi-asset world. With more areas that now potentially warrant investment, from property to asset-backed securities and P2P lending, multi-asset funds have become increasingly popular.
According to Investment Association figures, funds in the mixed asset category enjoyed net retail inflows of £2.6bn in 2016, making them the second most popular asset class for the year, after fixed income.
Several attributes have helped to boost the attraction of multi-asset products. But on a number of fronts, advisers have been warned not to shirk their due diligence and check allocations.
According to research undertaken by Hawskmoor, an investment firm, advisers have been shifting from single to multi-asset products for several reasons, including the ability to manage shifting market cycles via tactical changes in asset allocation.
Such switches, in either the asset classes or regions favoured within a portfolio, will have paid off handsomely for the more lucky or astute investors in the last year.
Those backing US equities, for example, may have participated in the 11.2 per cent rise in the S&P 500 in local currency terms alone.
But whether multi-asset managers are truly active when it comes to allocation decisions has come into question.
Rory Maguire, of ratings agency Fundhouse, warns that many portfolios have failed to apply a genuinely active asset allocation strategy but are 'herding' instead.
“Broadly we find they are not that active,” he explains. “There is a lot of herding around the sector average allocation, which can be argued is more about managing business risk than investment risk.
“The rise of risk ratings is partly accountable too, where asset managers feel compelled to deliver a fund that sits within asset allocation bands.”
This could be a failing, some suggest. Trevor Greetham, head of multi-asset at Royal London Asset Management (RLAM), argues that an active approach could be the key to exploiting market developments.
“A good asset allocation team should be able to add value through active management, shifting money towards more attractive investments as the macro-economic backdrop evolves,” he says.
However advisers should remember that asset allocation is not the only tool available in this space.
A multi-asset manager could, for example, maintain the same weighting to an area, such as UK equities, while fundamentally changing their approach by altering their holdings.
Those switching from small to large-cap stocks at the time of last year’s EU referendum, for example, may have enjoyed significant gains without significantly altering their UK exposure, as bigger firms with international earnings profited from the Brexit-induced tumble in sterling.
Similarly, some specialists have urged peers to view a consistent approach to asset allocation as a virtue.
Martin Bamford, an adviser at Surrey-based Informed Choice, comments: “Even actively managed multi-asset funds tend to be quite passive when it comes to asset allocation.
“They offer investors a good way to create the core holding within a portfolio, but few offer any dramatic tactical allocation management.
“I see this as a positive attribute of these funds, as investors should be prepared to stick with a strategic asset allocation position for the long term.
“There is a danger that by making regular changes to the positioning, the manager will simply incur additional costs and could risk missing market growth.”
Philippa Gee, a fund buyer and founder of Shropshire-based Philippa Gee Wealth Management, comments: “There is nothing wrong with a passive asset allocation or whether they are instead managed actively. The key is understanding exactly what type of fund it is and why it is worth considering.”
Other attributes commonly associated with multi-asset funds also appear to be causing debate.
According to Hawksmoor’s research, the unrelenting desire for income witnessed among clients has helped to boost demand for multi-asset portfolios.
Nearly two thirds of advisers responding to the firm’s study claimed the pension freedoms, which came into force in 2015, had increased the popularity of multi-asset funds as individuals look for income beyond annuities.
And with multi-asset strategies apparently playing a vital role in income generation, it is not surprising to see the other reasons cited by advisers for their appeal: the ability to preserve capital in falling markets and a “smoother journey”, aided by diversification.
There is some logic to this. Theoretically if equity markets, which have stormed a number of fresh highs in the US over recent months, were to fall, holdings available to multi-asset investors including gold and other defensive assets could potentially help to offset this by gaining value.
But advisers have been warned that merely investing in a variety of different things cannot guarantee real diversification for their clients' investment portfolios.
James de Bunsen, a multi-asset investor for Henderson, explains: “It is more than combining a number of assets. It is about looking for those that will perform differently in any different set of market conditions.
He notes that equities and bonds – the mainstay of many portfolios including some multi-asset products – could become “quite highly correlated” in times of heightened volatility.
As such, some have advocated funds that make the most of their multi-asset approach by seeking exposure to “alternative” asset classes.
This highly subjective term can range from relatively well understood areas like property to more niche pursuits, such as aircraft leasing and the use of derivatives.
Tim Stubbs, an investment consultant who has worked with advice firms such as Fiducia, said: “In effect, not being sufficiently diversified worsens your expected risk-adjusted returns – expect either a similar return for a higher level of risk or a worse return for the same level of risk.
“Adding multiple asset classes with somewhat independent return drivers is advisable, especially with respect to alternative asset classes such as property, commodities, infrastructure and absolute return.”
In one example, he noted that holding commodity stocks alongside a general allocation to equities could help balance the risks involved from a substantial movement in the price of oil.
While a rise in the oil price could dampen consumer spending and growth, hurting equity markets generally, commodity stocks would benefit.
Use of alternatives
Anecdotally, advisers working on model portfolios have become more comfortable with alternatives.
Earlier this year James Beaumont, head of the Natixis portfolio research and consulting group, noted that those running model portfolios had become more “picky” with the alternative funds they used as they grew more familiar with such strategies.
But alternatives may not be a panacea, with some raising concerns about this area. Mr Greetham, for example, warns that putting faith in areas such as aircraft leasing, which so far have been untested by a recession, could be ill advised.
The rise of alternatives partly reflects concerns about high valuations in both equity and bond markets, and the associated risk of prices falling significantly.
However these high prices, and the low-return environment investors find themselves in, mean that in some cases fund managers could be taking greater risk to meet income or return demands.
In some cases asset managers have responded to this by simply revising down their targets. Last year, for example, a number of funds dropped or amended their stated income goals, citing the prevalence of low yields.
But advisers have been warned to ensure they fully understand a manager’s approach in order to recognise if and when too much risk is being taken.
Alex Farlow, of ratings agency Square Mile, says: “Investors need to have a clear understanding of the income or return target of each fund, but also the level of risk which the manager can take in order to achieve this.
“Investors should look through to the underlying holdings to get an idea of what exactly they are investing in, and look at the risk, both from a volatility and drawdown perspective, over the longer term.”
Rory McPherson, a fund buyer for Psigma, stresses a focus on the basics: is a portfolio performing in the way it should?
“I’d hark back to transparency being key and fully understanding the risk being taken,” he explains. “The best way to spot if a manager is taking too much risk or not sticking to their knitting is watching their performance like a hawk.
“Manager process presentations are all well and good, but seeing is believing.”
FE fund analyst Amandine Thierree warns investors to beware of “style drift”, which is what happens where a manager shifts away from their stated approach.
An example could be value managers, having suffered several years in a “pro-quality” environment, shifting to some safer investments such as consumer-facing stocks before last year’s market rotation.
More broadly, advisers looking to follow the multi-asset trend should focus on performance, but also speak to managers in order to understand not just the investment process, but how a fund can be expected to behave in different environments.
This can be particularly important when fitting a multi-asset fund into a wider portfolio.
Scott Gallacher, financial adviser for Leicester-based Rowley Turton, opts to analyse a fund’s asset allocation and the level of risk being taken, both current and historic. But manager meetings provide an extra level of understanding, he believes.
“The fund manager contact allows us to understand the fund management approach on a deeper level,” he said.
“It’s not only about how the fund stacks up on its own, but also about how it complements or contrasts with the other funds we would use to construct a portfolio.”
David Baxter is deputy news editor for Investment Adviser
View from RLAM: What to look for in multi asset investing
Trevor Greetham, head of multi-asset and lead manager of Royal London Asset Management’s Global Multi Asset Portfolio (GMAP) range, provides an overview of key considerations for investors.
How active are multi-asset managers?
Most multi asset funds blend a range of asset classes to aim for a particular balance between risk and return over the long term.
Some go no further, resetting exposures to fixed weightings on a periodic basis. A good asset allocation team should be able to add value through active management, shifting money towards more attractive investments as the macro-economic backdrop evolves.
Some managers employ a committee approach to decision making, or rely on individual flair.
For a good track record to be repeatable, the investment process should be grounded in quantitative analysis of what has worked in the past, while leaving enough room for experience and judgement to play a part.
Our Royal London Global Multi Asset Portfolios (GMAPs) focus on tactical asset allocation as a driver of returns, above the underlying strategic asset mix.
The team employs a model-based framework for decision-making, a central part of which is our ‘Investment Clock’, which is our way of linking asset class returns to the global economic cycle, and is the product of over 20 years of research.
How important is diversification?
Poor diversification can result in nasty surprises. Most high-returning asset classes tend to become correlated during a crisis, as we saw in 2007-8 when stocks, property and credit all hit the buffers.
We like to include ‘safe haven’ asset classes like gilts, gold and absolute return strategies, which can do well at these times. Including a broader range of commodities can add resilience to unexpected geopolitical shocks.
Selecting the right balance of asset classes at the right time is a continuous challenge for portfolio managers.
Our GMAPs combine exposure to a broad range of asset classes in order to smooth the return profile, and provide the flexibility to adjust the allocation actively to seek returns and protect against risk.
The GMAPs aim to maximise real returns over the medium to long-term, subject to a given level of expected risk.
How do you balance diversification and risk?
Looking at a range of funds, it can sometimes be relatively easy to spot excessive risk taking. If a manager keeps piling ever more money into emerging market equities, for example, fund volatility may rise beyond an acceptable limit.
When reaching for returns in a low-yield environment, however, it can be harder to spot dangerous behaviour, as the more exotic high-yielding investments tend to be low volatility on a day-to-day basis until something goes wrong, a default for example, and you're landed with a large capital loss.
Be wary of funds with high exposures to ‘new’ asset classes that haven't been tested through a recession, such as peer-to- peer lending and aircraft leasing. These types of investments could prove troublesome as interest rates rise.
There is a broad variety of multi asset funds in the market, and investors and their advisers need to assess these different options carefully in order to find the right balance of risk and return to suit their requirements.
We believe multi asset investing has the potential to offer an attractive return profile in ever-changing market conditions. A robust tactical allocation process allows investors to exploit shorter-term opportunities and generate significant added value over time.
The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. For funds that use derivatives, their use may be beneficial, however, they also involve specific risks. Derivatives may alter the economic exposure of a fund over time, causing it to deviate from the performance of the broader market. Sub-investment grade bonds have characteristics which may result in a higher probability of default than investment grade bonds and therefore a higher risk. For more information concerning the risks of investing, please refer to the Prospectus and Key Investor Information Document (KIID).