Investors in multi-asset strategies must make sure they understand all the risks involved
• Multi-asset strategies have become popular
• It is difficult to devise a framework for risk assessment
• Comparisons with equity markets provide a guide
• Many dimensions of risk should be considered
Peer group comparisons were the predominant form of risk assessment during the 1990s when there were only five large fund managers in the UK who offered multi-asset ‘balanced funds’ to pension schemes. Such comparisons will always be of interest because of the competitive element of human nature. But are they the best way of assessing the likely risk facing the plethora of ‘targeted return’ and other styles of multi-asset strategies that have arisen particularly over the past 10-12 years?
Even for investment consultants for whom assessing manager skill and risk is their profession, it is not easy, says Willis Towers Watson ’s (WTW) global head of funds, Paul Berriman. “Risk within a multi-asset fund is difficult to get your head around,” he says.
Perhaps the key question that Berriman asks is whether anyone is good at managing such funds. The industry talks endlessly about trades that made money – emerging markets versus developed, and so on. But it is extraordinarily difficult to say whether a strategy is good or not. “Over the past decade, the only thing that mattered was whether a fund was in ‘risk on’ or ‘risk off’ mode. If they were in risk on, they made money, if risk off, they didn’t,” he says.
Yet investors need to assess the risks they are exposed to when investing in a multi-asset fund. Declarations of asset classes alone can be misleading. As many investors found to their cost in 2008, many multi-asset funds claimed to have a 40% exposure to equities but they did not fully appreciate how much exposure they had to the equity-risk premium. They also had allocations to hedge funds which were not market-neutral giving equity exposure and to private equity giving levered equity exposure. The mistake was to give a figure of 40% to equity market exposure. WTW finds that funds almost always have a higher allocation to the equity-risk premium than that.
In practice, there is a wide range of benchmarks that can be chosen alongside the inevitable peer group comparisons. That can make the problem even more confusing. There is, however, one clear guideline, at least for return seekers – the performance and risk characteristics of equity markets. As a stable real asset with dividends that should grow in line with global growth over very long time periods, even if subject to short-term volatility, they provide the reference asset class for investors. “If a fund can provide equity-type returns with less volatility, it is doing well,” says Berriman.
Multi-asset strategies should provide some benefit above that provided by a passive equity tracker. That cannot be in returns, so success needs to be measured with respect to volatility. Equities give a volatility of about 15% a year (the standard deviation of annualised returns) over the long term. A multi-asset portfolio that gives two-thirds of the upside in a bull market with half the volatility is attractive.
What of the downside? That, says Berriman, is where a manager’s skill can be assessed. Those who only get half of the downside are doing well. Unfortunately, though, over the course of the past five or 10 years, it has been difficult to achieve such a goal. Making money in a low-volatility world has proved difficult.
WTW finds that decent examples of success are few and far between. Reasons include areas such as transaction costs, which under MIFID II need to identified, quantified and measured. Many strategies do not work because the transactions costs have eroded potential returns.
In practice, firms offering multi-asset strategies use a wide range of benchmarks, but some are more accepted than others. Cédric Fontanille, head of external strategies within Unigestion’s multi-asset solutions team says the use of a 60% bonds/40% equities benchmark appears to be the most sensible approach. But he admits that the diversity of multi-assets funds is such that benchmarking is not entirely straightforward.
For absolute return outcome-oriented strategies, for example, BlackRock observes a range benchmarks for multi-asset funds across the industry from the UK retail price index plus 5% to cash plus 2% or 3%, says Dominic Byrne, a strategist at BlackRock. But, as he adds, volatility targets are also important. A portfolio that aims for about two-thirds equity market volatility compared with one that tries to deliver a third or a half would look fundamentally different. The first would have more structural exposure to risky targets to get to return targets. The other would be more active or dynamic and have more hedge fund-like strategies.
The third factor that needs to be taken into account is time period. “If a manager is trying to achieve return targets within a rolling three-year period, then the breadth of strategies available has to be greater than a manager attempting to achieve investment targets over a full cycle of five to seven years,” says Byrne.
So, for BlackRock, portfolio risk for multi-asset funds should focus on three elements. First, the absolute volatility of the portfolio returns; second, the beta of the portfolio with respect to equity markets; and third, the duration of the portfolio which gives an indication of sensitivity to bond yield changes.
“Macro hedge funds are one of the most expensive strategies in the hedge fund space”
WTW says a more multi-dimensional approach to risk assessment is required for multi-asset strategies to cope with their complexities. It looks at about 10 risk premia which include: mainstream equity risk; investment-grade credit; below-investment-grade credit; liquidity risk; insurance risk premia (catastrophe risks and so on); and manager skill.
Other more esoteric risks include term-risk premia – the slope of the yield curve, which is a small part of most portfolios and what WTW deems as complexity risk. There is still investor aversion to non-agency US residential mortgages after the 2007 crash, so there is a complexity premium whereby investors demand more return for investments they do not understand.
WTW finds that most strategies have exposure to two or three risk premia. The expected returns are then broken down into alpha and beta components, enabling assessments to be made of exposures to each risk component.
The results, says Berriman, can be revealing. Currently, for example, with concerns over markets, the issue is over how much beta risk that strategies are taking. “Whilst an endowment approach may typically have, say, 40% of the risk exposure on manager skill, most multi-asset portfolios have next to none embedded in future return expectations,” he says. This may well be by design, as many multi-asset strategies would claim their key expertise is in tactical asset allocation. Others would say their skill is in hiring outperforming managers.
Whatever the complexities of comparing multi-asset strategies with each other, at least there is a clearer distinction between them and macro hedge funds which, after all, are also multi-asset strategies of some form. Fontanille points out that multi-asset strategies are typically more liquid (daily, weekly terms) and their management fees tend to be moderate and generally without performance fees.
Macro funds are also more likely to have a bearish bias and tend to make more concentrated bets thus leading to more extreme returns. “Macro hedge funds are one of the most expensive strategies in the hedge fund space,” Fontanille says. On those grounds, multi-asset strategies may look attractive – provided the risks are understood.
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