Top 400: Multi-asset investing renaissance
Multi-asset strategies have many diversification benefits for investors in today’s challenging environment, according to Phil Edwards and Ben Lewis
Over the course of the 1990s and early 2000s, institutional investors (in particular UK defined benefit (DB) schemes) moved away from using a single balanced manager running a multi-asset mandate towards a specialist approach making use of multiple underlying asset managers. Research undertaken in the late 2000s found that over the period from 1984 to 2004 this shift had, in general, resulted in superior performance and reduced risk.
However, multi-asset investing is enjoying a renaissance, with many institutional investors making significant allocations to diversified growth funds (DGFs) and risk-parity strategies. This trend towards the modern incarnation of the balanced mandate echoes the observation attributed to Mark Twain that “history does not repeat itself, but it does rhyme”. Mercer ’s 2015 European Asset Allocation Survey, representing about 1,100 institutional investors and almost €1trn of assets, reports that 26% of investors had an allocation to at least one multi-asset strategy and that the average size of exposure was about 20% of total assets.
What has been driving this reversal of the long-term trend away from multi-asset managers and do such strategies make sense in the current market environment?
Multi-asset strategies offer investors several potential benefits. In particular, for investors with material fee or governance constraints, multi-asset strategies can provide access to alternative sources of return, such as hedge funds, real assets or alternative credit.
Additionally, such strategies are often actively managed, so that the allocation to different asset classes can be adjusted at any time by the portfolio manager. The manager is likely to be able to make changes to the structure of the portfolio much more quickly than the average institutional investor, thereby allowing more dynamic changes to the investment strategy in response to market developments. Finally, some multi-asset strategies will adopt a capital preservation mind-set and will introduce ‘hedges’ into the portfolio to protect against downside risks.
At a glance
• Multi-asset investing is enjoying a renaissance having proliferated in recent years.
• With bond and equity valuations so high investors should consider tilting towards strategies that depend on manager skill.
• Beta approaches still make sense for some investors.
It would therefore be wrong to label the use of multi-asset strategies as regressive or irrational – many investors find that they do offer some attractive characteristics. It is also worth noting that few investors have moved to anywhere near the 100% allocation to a single balanced manager common in the 1980s and 1990s.
The success of some early multi-asset strategies has seen a proliferation of products emerge in recent years. The universe of multi-asset strategies ranges from traditional long-only funds to some that start to resemble hedge funds.
The more simplistic multi-asset strategies are often anchored on a split between equity and bond markets, classically about 60% equity/40% bonds (or a risk-weighted allocation in the case of risk parity), with investments largely constrained to positions that benefit if markets rise in value (that is, long only investments).
Equity and bond returns have been exceptionally strong since the financial crisis and have left few large equity or bond markets in cheap territory. This makes for a challenging environment for strategies that rely heavily on equity and bond beta (market returns) as the primary source of return.
“Multi-asset strategies offer investors several potential ben efits. In particular, for investors with material fee or govern ance constraints, multi-asset strategies can provide access to alternative sources of return, such as hedge funds, real assets or alternative credit”
This leads to the conclusion that investors should consider tilting portfolios away from return-oriented strategies (those designed to capture traditional beta) towards those more dependent on manager skill (alpha).
This is reinforced by a belief that opportunities for skilled and flexible active managers may well have improved as economic and policy divergence combine to create more volatility and dispersion in markets.
With elevated volatility and downside risk to major market exposures, the benefits of a more dynamic approach and a capital preservation mentality (more common in what we describe as ‘idiosyncratic’ multi-asset strategies) are amplified.
The chart shows the performance of global equities, compared to the average core and idiosyncratic multi-asset strategy during the 10 worst months for equities over the last decade.
The chart illustrates how idiosyncratic multi-asset strategies, which tend to be less beta-dependent and have a greater focus on downside protection, have been better able to protect capital in falling markets than core multi-asset strategies, which tend to be more beta-driven and less dynamic.
Strategies employing leverage – for example, risk-parity funds – may find the current environment more challenging as reduced liquidity and heightened volatility increase the risks associated with leverage. Technically, the use of leverage makes an investor path-dependent, meaning the actions of such investors are, to some extent, determined by market movements (as opposed to unleveraged buy-and-hold investors, who can simply choose to ride out market volatility). Specifically, leveraged investors may need to replenish collateral positions should markets move materially against them – this might require them to sell other asset exposures, which could also be falling in value.
Although the current market environment does not lend itself to beta-heavy multi-asset strategies, they can make sense for some investors. In particular, heavily fee- and governance-constrained investors may have good reason to allocate to relatively straightforward multi-asset approaches as a low-cost means of achieving a diversified exposure across markets.
However, investors not significantly fee and governance constrained should consider reviewing allocations to beta-heavy multi-asset strategies. Such strategies may leave attractive sources of return, such as style-factor exposures, relative value opportunities and dynamic asset allocation on the table. Investors would be better served in the current environment by more dynamic mandates (for example, idiosyncratic multi-asset strategies or multi-asset credit funds) or by alpha strategies.
Phil Edwards is the European director of strategic research and Ben Lewis is a senior investment consulting analyst at Mercer Investments