Multi-asset: the diversifying factor

Written By: Venilia Batista Amorim LAPF Investments

explores the various strategies within multi-asset investing that can offer true portfolio diversification

When it comes to investing, it is common knowledge that diversification is crucial to success over the long term. It’s generally wise to avoid investing too much in one single asset class – investors could find themselves in a difficult position if that one single investment loses value quickly.

All too often, however, investors will fall into a trap of diversifying only within the same asset class. For many asset owners, it makes good financial sense to also invest in different types of asset classes.

Multi-asset strategies by and large allow managers to move within and among asset classes and, depending on the mandate, put on or take off risk as the environment demands. Given the current level of stock prices, a US Federal Reserve that cut rates three times in 2019, and a wealth of geopolitical uncertainty, multi-asset strategies may help institutional investors reach their returns goals.

Ben Yearsley, investment consultant at Fairview Investing, said: “In a recessionary environment it’s likely that equities, commodities and property will all suffer – even some corporate bonds too, with really only government bonds providing solace.”

It is important, therefore, that when designing a multi-asset strategy, a complete understanding of goals, risks and time frame is taken into account. Understanding the risk management component should also be a top priority because it’s crucial to building a returns-generating portfolio.

Meike Bliebenicht, senior product specialist for multi-asset at HSBC Global Asset Management, said: “Over the short term, correlations between equities and government bonds may increase in periods of market stress. The ‘taper tantrum’ in the second quarter of 2014 was an example of such a perfect storm, as was the start of 2018.”

She added: “Over the medium to long term there is a clear benefit from diversification, especially if we consider holding a globally-diversified portfolio against holding UK assets on their own.”

MJ Hudson Allenbridge was selected last summer by the Border to Coast Pension Partnership, one of the largest pension pools in the UK, to assist in the selection of a core multi-asset credit manager within the pool’s multi-asset credit fund. The amount allocated to the selected manager is expected to be up to £1.2 billion. “The objective of the portfolio is to gain broad exposure to the – predominantly sub-investment grade – credit market. Consequently, credit beta will form a significant component of the funds returns,” the pool stated.

In early 2019, Border to Coast also launched a search for a multi-manager portfolio in a bid to further diversify its investment strategy. “The key objective of the multi-manager mandate will be to provide exposure to specialist investment strategies that may not otherwise be captured in a predominantly large cap, global equity portfolio,” the tender notice stated at the time. “For example, giving exposure to small caps or regional specialists.”

Strategic and tactical asset allocation
Strategic asset allocation (SAA) is a portfolio strategy that involves setting target allocations for various asset classes and rebalancing periodically. The portfolio is rebalanced to the original allocations when they deviate significantly from the initial settings due to differing returns from the various assets.

Tactical asset allocation (TAA) is a multi-asset investment approach that encompasses a range of top-down macro investment strategies. The primary objective of TAA is to deliver excess returns to a portfolio via asset allocation – at the asset class, country, and/or sector level – rather than through individual security selection.

A TAA portfolio manager actively allocates across assets according to their assessment of opportunities and risks in the prevailing market environment. TAA mandates have flexibility on multiple dimensions, enabling managers to continuously and dynamically shift positions across various asset classes and instruments. TAA seeks to deliver attractive risk-adjusted returns while managing risk and potentially controlling drawdowns.

Diversified growth funds
Diversified growth funds (DGFs) are funds that invest in a wide variety of asset classes in order to deliver a real return over the medium to long term. Such funds are typically used as a replacement for a portion of the global equity allocation as a diversified means of looking for growth. There is quite a wide range of DGFs in the market place but typically these funds aim for a certain level of positive return or a certain level of return over inflation or over cash. The long-term aim is typically to produce a similar level of return to equities, but with about two-thirds the level of volatility of equities.

Katie Sims, head of multi-asset growth solutions at Willis Towers Watson (WTW), said: “Diversified growth funds are not performing as expected.” In the consultancy’s 2016 paper Diversified Growth Fund investing: Is there a better way, WTW highlighted that the DGF market was becoming saturated and was not delivering versus expectations. “We urged investors to investigate a better way. At a time of high popularity for DGFs, our paper and its suggestions attracted mixed reviews,” she noted. “Fast forward to 2019 and the conclusions from our 2016 paper remain valid, indeed the results of the updated analysis look worse,” Sims disclosed. “While some clear exceptions exist in this market, the average DGF is trailing performance expectations and failing to add value.”

Sims also believes that in the vast majority of DGFs portfolios there are still low levels of portfolio breadth and, thus, limited scope to outperform a 60/40 equity/bond portfolio going forward. “And while [WTW] is now far from alone in outlining the challenges facing DGFs, we believe the case for change is stronger,” she concluded.

While there are some clear advantages to DGFs and they remain a key building block in portfolio construction for certain types of asset owners, Sims believes the majority of investors should review their perspective on multi-asset investing.

Multi-asset investing can offer diversification, which can protect portfolios from volatility and major market downturns. But a multi-asset approach does have some drawbacks. For one thing, a multi-asset mutual fund will not perform as well as most stock funds in most years, because it will likely contain bonds, cash and other assets that may not earn the same returns. Those investors seeking maximum returns will likely make out better over time by investing in mostly equities.

Non-stock assets, such as bonds, are generally not designed to make an investor a lot of money. Rather, they are used to provide a steady stream of income and/or protect an investor’s portfolio from losses. During bad times in the stock market, a multi-asset approach can be essential. But when the stock market is doing well, investors may be missing out on big gains.

In addition, investors should be aware that the target date and target allocation funds often have higher management fees than funds containing a single asset. This is because the funds are usually actively managed by a professional. These fees can cut into overall investment returns over time.

A different approach?
What should investors look for in a multi-asset solution? The delivery of attractive risk-adjusted returns through genuine diversity including a broad opportunity set, specialist skill and high-quality security selection?

WTW’s Sims believes this may require a change in approach in order to achieve greater access to alternative asset classes and the illiquidity risk premia. “We encourage investors to rethink how they invest in DGFs, looking for those strategies that embrace an open architecture mentality.”

In the context of DGF investing, an open architecture approach is unbiased in its access and use of internal and/or external specialised managers, thoughtfully combined to create a well-diversified portfolio. Investors are better placed to exploit a full range of asset classes, including those with an embedded illiquidity premium, providing a valuable source of additional returns. This approach requires fund vehicles that are most constrained by daily liquidity, avoiding a mis-alignment of the liquidity of assets, client redemption and the associated risks, Sims said.

An open architecture approach is agnostic to the source of the manager skill, with a simple goal of exploiting the very best investment returns and no disincentives around allocating to specialists and more costly-to-access areas. A particular attraction is the scope for accessing those niche opportunities that offer outsized return potential through security selection, typically priced out of traditional DGFs due to tight cost constraints.

Loved by many, reviled by others, multi-asset strategies are undeniably a key feature of the investment landscape. In the US they are typically known as balanced strategies; in Europe and other parts of the world investors have been enticed by a category of investments known as DGFs. Whatever the label, however, the variety of strategies is broadening across the globe.

This represents an opportune time to revisit the way investors categorise the various strategies within the multi-asset universe. Investment consultancy Mercer tracks more than 300 strategies within the two major sub-categories of multi-asset investment – global balanced and diversified growth funds. “The changes we are making to our manager universe reflect the globalisation of the product offerings available and the innovation we have seen, particularly at the idiosyncratic end of the spectrum,” the firm said.