As bond markets grow more complicated, multi-managers may have something to offer investors who need asset allocation expertise, finds Fiona Rintoul. But these strategies are also competing against other forms of multi-approach investment.
It is no secret that multi-asset funds are rather popular at the moment. Whether you believe multi-asset funds are the greatest thing since sliced bread or think multi-asset is just a fancy name for a balanced fund, there is no arguing with the figures. Statistics from Lipper FundFile show that “asset allocation” was the most popular category in Europe in 2013 with inflows of $34 billion (€25 billion).
At the same time, funds that take a multiple approach – and there are several ways of describing that approach, including multi-sector, multi-strategy and multi-management – are on the rise within individual asset classes. Nowhere is this more true than in fixed income.
Multi-approach funds throw up much the same questions as multi-asset funds. What can a multi-approach fund do that a broad, diversified portfolio or series of portfolios can’t? And what about those double layers of fees? However, the reason for their popularity in the fixed-income sector is pretty clear.
“Fixed income is not doing its job; it’s not as easy as it was,” says Olivia Mayell, client portfolio manager on the global income fund at JP Morgan Asset Management (JPMAM).
The beauty of a multi-approach fund, particularly at a time when the hunt for yield requires a certain imagination, is that it provides flexibility. Indeed, the JPMAM global income fund takes its flexible search for income out the fixed-income sector into the equity sector. However, the key for Mayell is not how you define your universe but the flexibility you have within it.
“It’s tough to find good yields. Whether you abide by conventional fixed income or broaden out into convertible bonds and preferred equity, flexibility increases your chances of doing well. You can manage where the opportunities are.”
It’s an approach that might perhaps be called austerity asset allocation.
“It works best when you don’t have wide dispersion of opportunities, when you don’t have very high yields in above investment grade and very low yields in below investment grade,” says Michael Temple, who is the director of credit research US at Pioneer Investments and a manager of one of Pioneer’s multi-sector fixed income strategies. “When the opportunity set is less and markets are in difficulty, it makes sense to have a broadly diversified portfolio but one that can take advantage of opportunities as they occur,” Temple adds.
Certainly, multi-approach funds have found particular resonance in a fixed-income market that is largely determined by weird monetary policy.
“Asset allocation became more difficult because of the complexity of what different central banks around the world were doing,” says Temple. “The opportunity set for significant outperformance and alpha generation really dissipated.”
A better chance of doing well in this environment is broadly why both institutional and retail investors are increasingly turning to multi-approach funds for their fixed-income exposure. But risk mitigation is also a motivating factor – and one that may lead investors to a solution that uses several managers as well as investing in different sectors. One such solution is the Russell global bond fund, which invests in six external managers, including such well-known names as Pimco and Loomis Sayles.
“It’s a superior investment solution to a single manager fund,” says James Mitchell, senior portfolio manager, global fixed income at Russell Investments.
“The manager risk is diversified. There are a lot of different investment styles out there, and if you combine them in an efficient way, you can avoid concentration risk.”
In Mitchell’s view, provided you have strong manager research, a portfolio that is diversified in terms of managers, as well as sectors, produces a smoother return profile.
“There is a huge dispersion of returns within each sector,” he says. “If you look across the different sectors, the best managers typically deliver twice the returns of the worst.”
Russell Investments aims to find managers where there is a relatively low correlation between strategies, believing this brings down the overall risk of the portfolio. To ensure that the managers then combine efficiently within the Russell global bond fund, the company writes investment guidelines for each one. These might, for example, limit the risk managers take in certain areas. This means that, in essence, the managers provide a bespoke mandate.
“That’s the key difference between multi-management and fund of funds,” says Mitchell.
Some multi-approach funds follows a similar philosophy but with proprietary funds. The JPMAM global income fund, for example, invests in sleeves, each internally managed, and the sleeves are structured as securities. This delivers pools of capital to the portfolio managers, who then run that capital according to a specific mandate.
“We get them to come up with their best ideas – not just best ideas generally but best ideas to maximise income,” says Mayell.
In addition, says Mayell, this structure helps to keep costs low. “You own the security and so you know what’s in it. You’re not having to pay two layers of fees.”
However, not everyone is convinced that portfolios constructed in this way can totally avoid the law of unintended consequences.
“We don’t manage in a sleeve format,” says Temple. “The issue is that if you don’t have perfect communication within the sleeves, you can create a situation where you have overlapping or unintended bets. We see that as the downside of multi-management.” In some ways, this is precisely the problem that multi-approach funds were created to avoid. In an environment where optimum asset allocation in fixed income is an oft-changing beast, institutional investors in particular are increasingly turning away from single allocations to a selection of bond funds – whether organised by themselves or by consultants – and towards multi-approach funds in order not to end up with unintended bets.
“Increasingly, clients are looking to asset managers to make asset allocation decisions rather than doing it in-house,” says Temple.
“A lot of consultants felt that was the value they could bring, but as these strategies have become more complex it’s become increasing difficult for consultants to manage asset allocation.”
Of course, companies that do use multi-management or a sleeve format argue that overarching risk controls prevent unintended bets. “You need strong capital market skills and you need to manage the total portfolio,” says Mitchell.
In a multi-management format, deep and ongoing manager research is also essential. “We need to understand how a manager is looking to add value, which part of the market it is operating in, what its alpha sources are, where it gets its returns and its expected risk contribution,” Mitchell adds.
In this scenario, the blend of different return drivers is greater than the constituent parts of the whole. It can make it slightly trickier to tilt the portfolio quickly in response to market changes than it would be in a portfolio based in-house, where exposure can be dialled up or down very easily, but there are ways of dealing with that.
“It depends on how the fund is set up,” says Mitchell. “You can change the allocation between managers, you can move money into cash or you can control risk via derivatives.”
Mitchell also refutes the old criticism that multi-manager funds involve double layers of fees. “There’s just one fee for the client, and from that we pay out to the managers. We’re large and can typically get good fee deals. You’re likely to pay a little more for a multi-manager fund, but it’s a superior investment product.”
Whether multi-approach funds are sleeved or sleeveless, a potential advantage accruing to them all is that they can dabble in more esoteric areas of the market. In the current low-yield environment, this does bring obvious benefits.
“You can have slightly more concentrated portfolios and you can invest in securities in more interesting areas, because when you aggregate it into a broader portfolio it’s not a problem,” comments Mayell.
One company that is able to exploit such opportunities to the full is Smith & Williamson Investment Management.
It has two multi-asset funds of investment trusts, and the closed-end nature of the investment trusts allow it to access fixed-term opportunities that would otherwise be inaccessible. Meanwhile, its TwentyFour Select monthly income fund writes the book on small and unusual investments from mezzanine asset-backed securities to payment-in-kind notes. “It was launched with the specific view of taking part in smaller, less liquid bond issues,” says James Burns, a partner at the firm.
Smith & Williamson IM may be at the small, specialist end of the scale – the TwentyFour Select monthly income fund is closed-end and has a target size of £100-150 million – but these days, those are the kinds of pools where bond managers have to go fishing.
However, no one wants to rely exclusively on these specialist investments, and that is why multi-approach funds are on the up.
“Fixed income is becoming ever more complex,” says Mitchell. “Everyone can benefit from multi-management – big or small.’
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