A tactical game

Multi-asset funds have proved popular and the recession could further bolster their profile. But there are concerns over how many offer genuine multi-asset investing, high charges and tactical asset allocation. Jack Mulchand reports


Products investing in multiple asset classes have become popular in recent years. The difficult econo­mic and stockmarket outlook could raise their profile further as fund firms roll out offerings for investors chastened by the financial crisis.

The marketing story is typically that diversification across asset classes helps control volatility, while tactical asset allocation can boost returns. Such products are no doubt thought likely to strike a chord with risk-averse investors coming to terms with the worst financial crisis since the Great Depression.

“Over the last few years… big investment managers rushed to offer multi-asset class solutions, which was sometimes a particular fund product and sometimes a segregated-account approach,” said Guy Fraser-Sampson of the Cass Business School and author of Multi Asset Class Investment Strategy.
However, there are question marks over how many funds in the retail sector marketed as “multi-asset” truly offer genuine multi-asset investing.

Another concern is that they may charge high fees, as many use a multi-manager structure involving charges for the multi-asset fund itself and for the sub-funds it holds.

It may also be appropriate to be sceptical of a manager’s claim to add significant long-term performance through tactical asset allocation.

Research suggests that the passive performance of the asset class itself is key, rather than a manager’s adjustments to the standard, strategic portfolio weighting of the asset class.

For instance, a research paper by Gary P Brinson, L Randolph Hood and Gilbert L Beebower says nearly 94% of portfolio performance variation can be explained by strategic asset allocation. That in turn suggests stra­tegic asset allocation is more important than market timing or stockpicking.

But the concept for multi-asset investing itself – genuinely implemented – appears a good one. In fact, it goes back a long way.

It apparently makes an appearance in the Talmud, the ancient writings of orthodox Judaism. The Talmud ­recommends that one should divide one’s money equally between land, business and cash reserves.

Modern finance theory suggests that diversification across asset classes improves a portfolio’s risk-adjusted return. The idea is to benefit from holding asset classes that are lowly correlated with each other.

There are some who call this ­diversification benefit a “free lunch”. That is, a diversified portfolio can deliver the same level of return as one lacking diversification but for a lower level of risk.

Modern multi-asset investing is said to have been pioneered by the endowments managed by American institutions such as Yale and Harvard universities (see box, p22). It has more recently been spreading to Europe in the institutional and retail spheres.

“Successful multi-asset investing offers investors a stable core for their portfolios,” said Colin Graham, BlackRock’s head of diversified ­multi-asset portfolios, and manager
of the BlackRock Balanced Growth Portfolio.

“Broader diversification should, over time, lead to more consistent investment returns than would be the case if just one or two asset classes were relied upon.

“Dynamic asset allocation – the active selection of the assets most appropriate for the investment environment on a forward-looking basis – will also help through time, both in terms of seeking returns and reducing risk,” he said.

Graham added that longer-term trends in the economy and financial markets would likely boost the popularity of multi-asset investing. “For us, the period of long-term
disinflation and macroeconomic stability seen from the early 1980s to the early part of this decade is now over,” he said.

“This period represented a sweet spot for equities and fixed income investments, leading to higher valuations for both. It was very easy for a wealth manager to point to a graph and persuade his clients about the merits of long-term equity investment.

“By comparison, the past 10 years have seen developed equity markets produce zero returns, with periods of moves of plus or minus 30% within this trend. This is not such a persuasive story for investment in a single asset class, even for those who are willing to accept a high level of risk.”

Graham argued that current macroeconomic policy – namely, ultra-low interest rates and quantitative easing in rich countries – had increased “the probability of policy errors”.

Unexpected deflation or inflation could yet occur – he felt the latter was more likely – and the economic cycle could shorten. Graham said investors thus had to hold a wider range of assets, while multi-asset fund managers could seek to capitalise on economic and financial market volatility.

Performance data from Lipper provides some support for the diversification benefits of multi-asset investing over recent periods (see below). For instance, over the five-, three- and one-year time periods to May 29, 2009, the conservative, balanced and aggressive Lipper Global Mixed Asset sectors on average outperformed the MSCI World index.
On the other side of the coin, one problem faced by proponents of multi-asset investing is that many asset classes suffered steep losses last year.

But they typically argue that 2008 was a highly unusual year when the financial storm was at its greatest.

There was an almost indiscriminate flight from nearly all risky assets, they say, whereas the benefits of multi-asset investment should be evaluated over much longer time periods too, like 10 or 20 years.

“Ironically, multi-asset investing didn’t really work last year, as div­er­sification generally didn’t work,” said David Hambidge, the manager of the Premier Multi-Asset Distribution fund.

“However, we believe that this period will prove to be the exception rather than the rule, and that multi-asset investing should provide a smoother ride than more traditional managed funds.”

Hambidge argued that the multi-asset strategy was a workable one for the modern multi-manager, because the latter had greater choice and flexibility than before. This could be, for example, because Ucits III and Non-Ucits Retail Schemes (Nurs) afford greater investment flexibility than in the past.

“Whereas before the choice was typically equity or bonds, managers now have a choice of numerous additional assets including property, commodities, hedge funds – all within either an open-ended or closed-ended structure,” Hambidge said.

Lipper in its sector definition says a multi-asset fund is one that invests strategically in fixed income and equity securities. But that is by no means the definition agreed industry-wide, as the statement from Hambidge above emphasises.

This raises an important issue – the fact that the term “multi-asset” is used loosely in the retail fund sector (see box). It can cover multi-manager and non-multi-manager products.

It can also embrace funds with different exposure.

This confusion can work well for the purposes of marketing if multi-asset becomes a popular theme with retail investors. A firm can just graft the term “multi-asset” onto a portfolio without having to worry too much about meeting a stringent definition of multi-asset investing.

Rob Burdett, the co-head of Thames River Multi-Manager, said he was “slightly wary of the term ‘multi-asset’. We have a fear this extra piece of industry jargon – surely just another phrase for diversification – could be jumped upon by marketing-led fund managers to launch products with asset mixes that work on back testing, only to disappoint in the future.”

Fraser-Sampson from Cass Business School contends that one necessary condition for proper multi-asset investing is a minimum number of asset classes going beyond just stocks, bond and cash.

“There is an optimum number of asset classes,” he said. “Most people who believe in multi-asset class investing would probably say it’s between five and eight.

“You need enough asset classes that are lowly correlated enough to give you diversification. And the research tends to say you need at least five for that. But you don’t want to make an allocation to anything that is too small to be sensible.”

For instance, academic work by Niels Bekkers of Tilburg University, and Ronald Q Doeswijk and Trevin W Lam from the Institute for Research and Investment Services, looked into creating the optimal portfolio from a selection of 10 asset classes.

These were stocks, government bonds, cash, private equity, real estate, hedge funds, commodities, high yield, credits and inflation-linked bonds.

The research paper looked at the level of correlation between these different asset classes, and concluded that “adding real estate, commodities and high yield” to the traditional asset mix of stocks, government bonds and cash yielded the “most efficiency improving value for investors”.

But Fraser-Sampson said it was a hard task for an investment manager to create a genuinely multi-asset product. Some offerings delivered only a limited range of assets, with private equity often a “glaring omission”,
he argued.

“Multi-asset should be available to retail investors… [But another] problem will be the perceived need to graft liquidity, and fees because it will probably be a fund of funds,” he said.

Of course, regulated retail funds typically offer high levels of liquidity, whereas Fraser-Sampson said that “if you are investing in such things as private equity, infrastructure, and property, which are by their nature illiquid, it’s very difficult to graft a shell of liquidity, or the appearance of liquidity, onto that”.

He added that “liquidity comes at a very heavy price, in the shape of lower investment returns”.

The Cass academic recommends that perhaps one of the best options for investors is to build a multi-asset class portfolio themselves, using exchange-traded funds (ETFs).

“I would look to put together five or six asset classes as ETFs and forget about private equity for the time being,” Fraser-Sampson said.

Implementing such a strategy still requires a long-term focus, however.

It is also worth noting that many ETFs are dollar-denominated, which would imply taking on currency risk.

However, ETF options are growing all the time.

Another brewing problem with multi-asset investing is that it could become conflated with absolute return investing, which aims to make a ­positive return over a specified time period, rather than to simply beat a benchmark index.

Absolute returns funds have proved increasingly popular in recent years. They are, in some ways, similar to multi-asset funds in that they seek to reduce volatility.

“We believe absolute return funds will increasingly form a central part of investors’ portfolios because of their potential ability to smooth returns and deliver positive returns over each market cycle,” said Rob Page, the marketing director at Liontrust.

Some multi-asset funds are abso­lute return vehicles. But many of the latter, such as Liontrust’s offerings, are not multi-asset.

In fact, multi-asset investing per se promises only to improve risk-adjusted returns, not to deliver positive returns over a particular time period.

“Multi-asset should not be confused with absolute return,” said Premier’s Hambidge.

“People have often made the mistake that multi-asset class investment should produce positive returns. But all it says is that it should produce non-correlated returns,” says Fraser-Sampson.

In sum, multi-asset investing offers diversification benefits. But achiev­-ing true multi-asset investing at
reasonable cost is unlikely to be an easy task. Investors may be better off building multi-asset exposure through an infrequently traded, strategically allocated multi-asset portfolio of ETFs held for the long-term.

Even then, they should not necessarily expect the returns enjoyed by proponents of multi-asset investing in the past.

“The past 10 years have seen periods of extraordinary investment results,” the Harvard Management Company (HMC), one of the leading exponents of multi-asset investing, said in its most recent financial report.

“In light of recent market stress and dislocations, however, HMC is keenly aware that returns produced
in the next few years may fall well short of these robust historical levels.”

References
l Gary P Brinson, L Randolph Hood and Gilbert L Beebower, Determinants of Portfolio Performance.
l Niels Bekkers, Ronald Q Doeswijk, Trevin W Lam, Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes.


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