Multi-asset funds: Diversity among the diversified
Multi-asset funds encompass a wide range of strategies. Brendan Maton and Charlotte Moore profile three such portfolios
Aviva Multi-Strategy Target Return fund
• AUM: €3bn (Aug 16)
• Gross return target: 5% above the Bank of England base rate, before fees, over a rolling three-year period
Aviva’s Multi-Strategy Target Return (MSTR) fund tries to avoid the pitfalls associated with more traditional diversified growth funds.
Brendan Walsh, co-manager of the fund, says: “When volatility is high, bonds and equities become highly correlated causing these funds to underperform.”
The fund tries to avoid these pitfalls by expanding the sources of return away from equities and bonds by allocating to different strategies, rather than assets.
The fund aims to deliver 5% returns over cash on a rolling three-year target, regardless of market climate and conditions. In addition, the fund has a volatility target of 30% to 50% of global equities.
Risk is allocated to ideas rather than selecting specific assets. “We make strategic three-year investments and take no tactical positions or engage in hedging,” he adds.
The philosophy is to deliver equity-like returns over a rolling three-year period but at much lower volatility.
Walsh says: “This investment strategy can only be successful if there is a strong enough stream of ideas and there is a tight framework and process.”
MSTR is effectively divided into three sections. One part of the fund is similar to more traditional asset-allocation portfolios. Walsh says: “This part of the fund will have both long equity and bond positions as well as some short positions.”
It currently has a short position on the 10-year Bund and a long position on US high-yield. It is also long Japanese, emerging-market and US equities.
But it will not be possible for the fund to reach its target return with this part of the portfolio, as fixed-income yields are so low.
Walsh says: “To access greater returns, we also implement strategies such as currency positions, relative value and volatility which are similar to those found in a global macro hedge fund.”
In this part of portfolio, the fund takes on positions with little or no traditional risk premia.
While MSTR has profited from its long dollar position in recent years, it is moving towards a more neutral position. Walsh says: “We are now long emerging-market currency and carry, which we access using both bonds and currency.”
This reflects the fund’s view that central banks will pursue a loose monetary policy for longer than had been anticipated, which will underpin emerging-market foreign-exchange markets.
“Lower yields for longer also mean we need to find additional sources of carry,” says Walsh.
The final leg of the fund aims to reduce the overall risk of the portfolio. Walsh says: “This part of the portfolio must not, however, drag down overall returns.”
That means the fund does not buy insurance in the form of put options. He adds: “Instead we look for ideas which are diametrically opposed to the central view of the portfolio.”
For example, the fund has a number of long dollar positions – against sterling, the Australian and the New Zealand dollar. “In ‘risk-off’ markets, the dollar acts as a safe haven,” Walsh says.
The fund is long US large-cap stocks and short small-cap stocks. “If the markets are worried about recession, large cap outperforms small cap,” he adds.
Insight Broad Opportunities Strategy
• AUM: €5.3bn
• Gross performance target: Cash-plus 4% annualised over 3-5 years
• Gross performance annualised since inception (Dec 04): 6.8%
• Sharpe ratio: 1.13
After the tech crash at the start of this century, Europe’s pension funds started casting round for protection against the worst of market falls.
At the same time, hedge funds were looking to broaden their appeal beyond the world of New York’s super-wealthy.
The two worlds met but the relationship has never grown strongly. The reason is because traditional asset managers have adopted hedging strategies and now run far more money this way than the original ‘pure’ hedge funds themselves.
A good example of how to mix long-only and hedging techniques is the Broad Opportunities Strategy of Insight Investment. Insight is popular for liability-matching and fixed income strategies but not an obvious choice in multi-asset, let alone funds using a lot of derivatives. Yet the Broad Opportunities Strategy aims to earn half its return from techniques that, when structured correctly and viewed in aggregate, are not dependent on market direction for their success. (Insight uses the term ‘less directional’ rather than ‘non-directional’.)
“The Broad Opportunities Strategy aims to earn half its return from techniques that, when structured correctly and viewed in aggregate, are not dependent on market direction for their success”
The strategy was launched in 2004 with money from one of those long-term investors disgruntled with losses after the tech crash. “They weren’t after higher returns but didn’t want us to lose so much on the downside,” says Matthew Merritt, who has run the Broad Opportunities Strategy since its inception, and who has broader responsibility for strategic and tactical asset allocation at Insight.
So far the strategy has strayed below its benchmark of cash-plus 4% on a rolling three-year basis only in the depths of the great financial crisis. The annualised gross return has been 6.8% for 6% annualised risk. All satisfactory, and superior to a passive 60/40 equity/bond split, although Merritt says that the contribution from the less directional elements has averaged more like 40% than half over time.
The kind of hedge fund technique used includes range-bound short straddles, where the strategy exploits the general propensity of investors to overpay for protection. Merritt says this is where insurers generally earn their money. At the moment the Insight strategy has a straddle on the Korean stock market, betting against an extraordinary break-out in the near future.
Merritt’s Brexit play was to go long the FTSE100 index and short the FTSE250 index of mid caps, on the assumption that a weaker sterling would benefit the big exporters in the large-cap index while prospects for FTSE250 companies, which are more connected to the UK economy, would be dimmer.
Merritt gives another, much more straightforward opportunity to collect risk premia, when during the sovereign debt crisis of 2011-12, the strategy went long Bunds over the sovereign debt of peripheral states such as Portugal.
On the long-only side, the strategy looks at equities, bonds and real assets. In the latter category is infrastructure, an asset class much discussed by pension funds these days. The dilemma for the pension funds is getting comfortable with the cost and value of long-term commitments.
As a fluid allocator, the Broad Opportunities Strategy is not going to go direct, so its route to exposure is by buying shares in listed infrastructure vehicles such as HICL and 3i Infrastructure.
And relative to ‘pure’ infrastructure investing, or indeed ‘pure’ hedge funds, the Insight strategy is keenly priced for institutional clients.
Invesco Balanced Risk Allocation
• AUM: €14.2bn
• Gross performance target: Cash-plus 6% annualised over 3-5 years for volatility of 8%
• Gross performance annualised since launch (Sep 08): 9.3%
• Sharpe ratio: 1.1
Launching any investment product on 30 September 2008 during the global financial crisis was never going to be easy. For Invesco’s Balanced Risk Allocation (IBRA), witnessing capital markets on which all tradeable securities appeared to be falling in tandem, it was a challenge to find anything holding up. IBRA lost 12% in October but had managed to make most of that back by the end of the year.
“Diversification was temporarily wiped off the map because all asset classes were going down,” recalls George Avery, senior product manager for global asset allocation at Invesco. “But we didn’t make any changes to the fundamental strategy.”
That first month has a substantial impact on performance. To the end of August 2016, gross annualised returns would be 11.2% excluding October 2008 but 9.3% including it. Avery, however, prefers to talk in terms of Sharpe ratios. IBRA’s realised Sharpe ratio exceeds 1, far above its target of 0.75 and a 60/40 equity/bond comparison, which stands at 0.62 over the same period.
He talks of Sharpe ratios because IBRA looks at weightings by risk rather than return or asset volume. It is a risk parity strategy that gets categorised in some European investment databases as a Diversified Growth Fund (DFG) (by one universe, Invesco is the fifth biggest house in the cash-plus 5-7% DGF category).
Invesco’s team, led by Scott Wolle in Atlanta, selects assets for three different economic scenarios: inflationary growth, non-inflationary growth and recession. In the DGF universe, IBRA stands out for its use of commodities for periods of inflationary growth.
Starting with just four in 2008, coveringthe key complexes of energy, metals, foodstuffs and gold, IBRA now has 23 commodities on its roster.
Always using derivatives to gain exposure, one salient idea is to exploit those commodities with storage difficulties. Another is to go out further along the curve rather than mechanically take the next month’s roll as index investors do.
Like many other multi-asset allocators, IBRA sees the potential for zero contribution from long-term government bonds, the main component of its ‘recession investments’, in the years ahead. This was not how risk parity started and does not reflect the strong returns from bonds, including the first half of this year. But the criteria for recession investments have been modified as quantitative easing by central banks has grown.
In 2012 the team switched from historical yield volatility as a measure of government bond risk to modified duration-based weighting.
In 2015 a yield-skew adjustment was introduced because of concerns that government bond yields of large developed economies could easily go into negative territory. This would spell failure of recession investments to do their job of preserving capital when stocks and commodities depreciate.
Both Japanese government bonds and Bunds have since been excluded for this reason, although the strategic exposure to Gilts has risen to over 12% in the bucket as a consequence. So IBRA has adjusted its thinking but it has not lost belief in the role of long-term government debt as a refuge in bad times.
Like many multi-asset strategies, IBRA has consistently delivered in excess of its target return. Given the protracted bull run in bonds and general economic uncertainty, does Avery feel that clients should expect lower figures in the years ahead?
“No. I believe, even with modest asset class assumptions, we can achieve our Sharpe ratio goal going forward,” he replies.
Commodities are key, given the sell-off over the last few years. Tactical asset allocation deserves a mention, too, because IBRA expects this element of the strategy to deliver 15-20% of total returns.
Momentum Diversified Target Return
• AUM: €78m
• Performance target: Cash-plus 3% annualised over 5-7 years for volatility of 6-10%
• Net performance annualised since inception (Sep 08): 7.9%
• Sharpe ratio: 1.1
The diversified growth funds (DGF) sector is renowned for its heterogeneity. The Momentum Diversified Target Return (DTR) fund is characterised by a periodically high exposure to convertibles – over 14% at the end of August.
Alex Harvey, Momentum’s head of fixed income, explains the diversification benefits of convertibles simply: “It’s better than buying a combination of bonds and equities.”
In particular, Momentum is looking to exploit the convexity of convertibles: their richest middle range where both the upside potential conversion to shares and the downside protection as fixed income are highest.
And Momentum’s exposure to convertibles changes over time, tending to rise and fall inversely to the DTR fund’s high-yield debt exposure.
As often is the case with DGFs that use third parties, there is this strategic and dynamic diversification by asset class but then another, underlying diversification by manager style. This is to be expected for a strategy that lists a total of 28 underlying active managers to which it has access.
It is a dazzling roster for a fund with less than €100m under management. Part of the explanation is that with €1.7bn under management in multi-asset strategies, Momentum can negotiate good prices with its active managers. Harvey also claims that buying and selling funds is not a drag on costs.
It is intriguing, nevertheless, to see which categories are most populated. There are 14 managers for developed equity, plus three for quality equity and one equity risk premia strategy. There are three underlying strategies for convertibles.
But emerging market equities are accessed solely by using the MSCI EM index future. “Valuations in emerging market equities have been compelling for some time relative to developed markets,” says the DTR fund’s portfolio manager, Andrew Hardy.
So why passive exposure here when the inefficient nature of emerging markets (and emerging market indices) are most suited to exploitation by active management? Hardy says Momentum is aware of the risks of EM indices, notably the political risk and mismanagement of state-controlled enterprises.
He agrees that emerging markets are inefficient but he reckons that many of the ‘star’ active managers in emerging market equities are focused on the consumer story and quality growth names, which are not cheap.
One criticism of DGFs is that net of fees many of them have not done much better than a 60/40 equity/bond allocation.
Why bother with unusual asset classes, convexity and at-the-money optionality, let alone a spectrum of underlying styles? Hardy’s answer lies in the future. He does not see how the bond bull run can continue for another 15 years.
So investors are going to have to work harder to earn a similar level of risk-adjusted returns, and Momentum says part of that extra labour has to include dynamic asset allocation.
Newton Real Return fund
• AUM: €11.6bn (Jun 16)
• Aims to return Libor-plus 4% annualised over a rolling five-year period
• Annualised return over five years: 4.8%
Newton’s decision to launch its Real Return fund was in direct response to the changing risk-return profile of financial markets. Aron Pataki, portfolio manager and risk strategist, says: “The previous cycles of long, steep equity market returns with limited volatility will not be repeated in the future.” Instead, economic growth will be lower, business cycles will be shorter and returns more variable.
“A multi-asset flexible fund will be better able to produce decent returns in an environment when market trends will no longer be the friend of the investor,” he adds.
To match this dynamic approach which shuns benchmarks, the best return target is one that aims to generate returns greater than cash, irrespective of market conditions. Pataki says: “Our fund tries to identify individual securities which will perform well in the expected economic backdrop.”
The fund is relatively concentrated with about 55 stocks, 15 corporate bonds along with some exposure to commodities and government bonds.
Pataki says: “We have a very broad universe to select from, including alternatives, as long as they comply with our liquidity constraints.”
The fund selects securities based on investment themes. “We take this approach because we realise we are just as incapable as everyone else at forecasting the future,” says Pataki. It is better to focus on key trends that are likely to influence economies and stock markets in the long run, he adds.
This focus on structural trends helps the fund managers look long term. The fund currently has about 15 themes, which include longevity and debt burden.
Pataki says: “For a security to be included in the portfolio, not only does it have to benefit from one of these investment themes, it must also have fundamental support, and valuations have to be attractive.”
Stock selection is influenced by the fund’s view of the macroeconomic outlook. Pataki says: “We think that market risks are rising, so we do not want take too much cyclical exposure with our equity holdings as these instruments are in the riskiest part of the capital structure.”
The fund’s holdings are in those stocks that can generate stable cash flows independent of the economic cycle, such as healthcare and utility companies.
As corporate bonds are higher up the capital structure, the fund can afford to take more cyclical risks. Pataki says: “We have exposure to financial and industrial bonds in this part of the portfolio.”
The fund has different risk management tools at its disposal. Pataki says: “We use gold to hedge against policy errors and currency debasement.” We use currency and government bonds to indirectly hedge against equity and corporate credit, he adds.
While the fund does not take any short positions in its underlying stocks and bonds, it can use derivatives to create short positions for hedging purposes to lower the volatility of the fund and to ensure capital preservation, says Pataki.
But getting the asset allocation right is the most effective way to manage risk. “In 2008, the fund generated a 6% return with a long-only portfolio with a 30% exposure to equities.”
The level of hedging present in the fund will depend on how optimistic the managers are about the outlook.
Pataki says: “If we have a more cautious view of the world, the hedging layer will become much more substantial.”
Pioneer Absolute Return Multi-Strategy
• AUM: €798m
• Target return range: Euro Overnight Index Average plus 3.5-4.5%
• Performance: 3.59% (five-year annualised)
Even within the sub-sector of multi-strategy funds, there are nuances in investment philosophies. Davide Cataldo, manager of Pioneer’s Absolute Return Multi-Strategy (ARMS) fund, says: “We view a strategy as the best way we can implement an investment idea.”
It can be as simple as taking a short position on European banks. “Or it can be more complex such as taking long inflation positions on a number of different curves around the world.” This strategy is implemented using both inflation-linked bonds and inflation swaps.
Pioneer aims to maintain a long-bias in its absolute-return multi-strategy fund, but it can go long or short on any particular asset class. Cataldo says: “While we implement a high number of relative value trades, we also try to capture the market risk premium.”
The fund aims to generate annual returns of 350-450bps over the Euro Overnight Index Average (EONIA) on a rolling three-year basis. While the fund has a maximum value at risk of 6%, it is typically between 2% and 4%.
Current volatility is a little less than 3%. It achieves these targets by dynamically managing its allocation mix.
These asset allocation moves will often be significant and swift. Cataldo says: “Within a few weeks, we moved our equity asset allocation from 30% of the portfolio to -5%.” Similarly, dollar positions were cut from 25% to 5%, while duration was shifted from more than four years to less than two.
Cataldo says: “We aim to generate returns not only from our view on the market but also through portfolio construction and risk management.”
There is a multi-layered approach to the fund’s investment strategies. As well as a core and satellite approach, the portfolio invests in some corporate bonds, as well as employing a risk-management strategy.
The core ARMS portfolio is invested in fixed income, real estate, currencies and commodities. These holdings reflect long-term themes such as the growing importance of robotics, increases in longevity and the transformation of the energy sector.
The fund will use the investment which represents the purest expression of a particular idea. Cataldo says: “For example, our view on the robotics revolution is expressed through a basket of specific stocks.”
The risk of the fund is assessed monthly using an internal survey of all the firm’s multi-asset managers and analysts.
“We define a set of risks and give each event a particular probability,” says Cataldo.
If the impact of the event and the probability of its occurring is high, the portfolio is hedged against that specific event. “We take these steps because we invest in high-conviction ideas which can prove to be wrong over the short term,” says Cataldo.
“Hedging can be expensive so we try to use the smartest possible techniques.” For example, the fund hedged against the UK’s vote on the EU by going long the Swiss franc against sterling.
In addition, the fund hedged its equity and interest rate positions using options. “If protection is too expensive, however, we will focus more on the portfolio’s asset mix,” he adds.
The satellite portion of the ARMS portfolio tends to focus on relative value trades which have a low correlation to each other, and to the macro strategies, says Cataldo.
The fund also invests in corporate bonds with low levels of duration and credit risk to generate income and increase portfolio diversification.
Cataldo says the strength of the fund comes from these multiple approaches. “True alpha is not generated from single trades. It is the result of a carefully built portfolio of independent strategies,” he says.