October 2014

MULTI-ASSET FUNDS: Multi-asset inflection points

Floating houseEvents such as the Scottish referendum are a chance for multi-asset funds to boost returns by tactical allocation, say managers. But is it really possible to second guess the market like this? George Mitton reports.

Great global events are like rivers. They begin as a trickle, turn into a stream, grow into a torrent of news headlines, analysis, opinion – then they strike, like a flood, and all who were unprepared end up being washed away.

The Scottish referendum on September 18 was such an event. From small beginnings it came to dominate the news in the UK and in Europe, prompting a sell-off of the pound as the prospect of independence became tangible.

For multi-asset fund managers, this was a chance to prove their worth by preempting market movements and taking shrewd allocations. 

Such inflection points occur all the time, they say. But are these fund managers really any good at predicting the future?

Some months before the vote, the multi-asset department at Legal & General Investment Management brought in political specialists to discuss the Scottish referendum. At the time, the accepted opinion was that the result would be a clear “no” vote. The specialists thought the race would be tighter than that. As a result, the Legal & General team began to think the market was underpricing the risk of a “yes” vote and reduced their exposure to the pound.

“Were there other asset managers having these debates? Yes, but they were mainly in the UK,” says Emiel van den Heiligenberg, head of asset allocation at the firm. “This was not on the radar of the average Asian or continental European investor. We knew the moment there was a survey which predicted a ‘yes’ vote to win, Asian investors would wake up and start to sell the pound. We needed to be in front of that.”

Multi-asset fund managers like these discussions because it concerns their unique selling point: tactical asset allocation. Their argument is usually like this: a pension fund client does not have the time or the expertise to make asset allocation decisions that preempt market events, so they should give their money to a multi-asset fund manager who can do a better job. Fund managers’ skill justifies the comparatively high fees that multi-asset funds usually charge, they say.

The only problem is that not everyone believes in fund managers’ ability to make the right calls. 

A recent survey by alternative manager Aquila Capital found only one in ten institutional investor respondents believe it is possible to predict market movements sustainably at the stock, industry sector, country and asset class level. Even the fund managers themselves are honest about the difficulty of predicting the market.

Van den Heiligenberg admits that “short-term market timing is extremely difficult”. Many drivers of what’s going to happen today, this week or this month are affected by sentiment, by news flow and by events that are impossible to predict. Even matters that ought to be under human control – the effects of central bank policy, for instance – are hard to guess, not because of the central bankers themselves but because of the way human beings respond to information. How can multi-asset fund managers claim to be good at tactical asset allocation when the world is so unpredictable?

Van den Heiligenberg’s response is interesting. He says it is easier for a top-down, macro-style fund manager like him to make predictions in the long-term than in the short. It is a counterintuitive idea. If someone cannot predict what will happen tomorrow, why would you trust them to predict what can happen in five years? Perhaps a simile will help to explain.

“You could compare us to the weatherman,” he says. “It’s difficult to predict if it will rain in west London tomorrow. It’s easier to predict if climate change will change the average temperature in west London in 15 years’ time.”

Van den Heiligenberg believes his team can forecast with a good rate of accuracy trends such as growth of emerging market equities or rising interest rates. He doesn’t claim his team get it right every time, but by spreading their bets over 25 to 30 different trades, they give themselves more chances to succeed. If the fund managers can achieve a success rate of 60% or better, they will achieve stable, positive returns for their investors, he says.

Of course, that all depends on those fund managers getting it right more often than they get it wrong. Van den Heiligenberg was unwilling to say the success ratio of his fund.

Whether you believe it is possible to time the market or not, there is no disputing the popularity of multi-asset funds. Sales of these products in Europe were €62 billion in the first half of this year, according to data provider Lipper. Asset allocation funds, a sub-category defined as funds with no asset allocation restrictions, had more launches in the first half of the year, 134, than any other fund type.

However, there are some problems with tactical asset allocation. One criticism is that if fund managers are very active, it implies a lot of trading, and this incurs transaction costs that the end investor has to pay. Instead, some argue it is better for investors to adopt a “buy and hold” allocation – spread your risk and stay the course for the long term. But if this is the best strategy, why is it worth paying a fund manager at all?

John Finch, director, investment consulting, JLT Employee Benefits, says there is still a value in having a fund manager involved, even if he or she spends of most of the time doing nothing. “For the manager, it is important to have the courage sometimes to sit on your hands and not tinker. But there are certainly inflection points in markets where you need to take action,” he says.

An example where it would have been folly not to adjust one’s asset allocation, he says, was during the financial crisis of 2008. Finch recalls that amid the chaos, the spread between government bonds and double-A rated corporate credit reached 280 basis points. Corporate bonds were extremely cheap, effectively cheaper than equities. “It became a raging buy,” he says. “An incredible opportunity.”

Managers of multi-asset funds could respond quickly to this price disparity, and pass on returns to investors. In contrast, those pension funds that cannot make rapid asset allocation changes missed out.

Another example occurred some years earlier when, during Margaret Thatcher’s period as prime minister of the UK, the pound fell to $1.05 against the dollar. Again, says Finch, this was an inflection point that allowed tactical asset allocators to make good returns.

“There was no way she would allow parity with the dollar,” he says. “It was the ideal time to switch investments around to take advantage.”

Such clear opportunities to make money do not come around often. As a consultant, Finch is sceptical about fund managers’ abilities to consistently time the market. “From my experience, making strong allocations and leaping from one market to another market, actually doesn’t work. And I’ve never seen anyone who consistently gets that right.”

However, he does believe in the value of acting quickly when good opportunities arise, and he also argues that multi-asset fund managers can lower their clients’ risk by sensible asset allocation.

Perhaps investors should remember that inflection points can be opportunities for managers to limit losses, not just to make gains. Talib Sheikh, manager of the JP Morgan Funds Global Income Fund, says investors received a wake-up call last year, when markets anticipated the news that the US Federal Reserve would begin tapering its bond purchases.

“The taper tantrum showed people were taking more risks than they thought,” he says. “There can be a period where bonds and equities both do badly because of liquidity.”

Sheikh says the advantage of today’s multi-asset funds is that they will lose less in a down market than a bond or equity product because they invest in a range of assets including alternatives. This constitutes progress from the days when the only multi-asset options were balanced funds, which could spread risk only between equities and bonds.

This defensive quality is important because Sheikh is also sceptical about the possibility of making returns by predicting market movements.

“It’s incredibly difficult. I don’t think that’s controversial. The thing people forget about timing the market is you have to get it right twice. You’ve got to get it right going from cash to bonds or equities and right coming out to book that profit.”

Sheikh’s view is that multi-asset fund managers exist to reduce clients’ risk. He does think a canny fund manager can do well by buying assets that are undervalued – “Without sounding glib it’s about buying things you think are cheap” – but the main purpose of his fund is to give clients the benefits of diversification.

Perhaps, then, tactical asset allocation should be seen less in terms of preempting market events and more as a way to prepare for a range of possibilities. When questioned, most multi-asset fund managers are generally not brave or foolish enough to claim they can predict the future. But they do think they can protect their investors’ money better than managers of pure equity or bond funds, and they like to think they can earn a few extra basis points by some clever trading here and there. Whether investors think the fees charged are worthwhile depends on how much they fear the flood-like effects of those major global events.

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