No-one genuinely expects multi-asset funds to keep up with equities in strong bull markets, our panel is told. So don’t give up on diversification.
William Martinez (investment specialist, Aberdeen Standard Investments)
Francesco Sandrini (head of balanced, income and real return, Amundi Asset Management)
Chris Murphy (client service director, Baillie Gifford)
Simon Woodacre (senior investment research analyst, Buck)
Peter Martin (investment officer, Medical Defence Union)
Tom Wake-Walker (senior vice-president, Redington)
Funds Europe – Briefly, could you summarise how you perceive the mood to be in the multi-asset fund sector at the moment, citing one opportunity and one challenge?
Francesco Sandrini, Amundi Asset Management – The mood is certainly a mixed mood in the sense that we are all to some extent waiting for the market correction. We have fundamentals from the markets deteriorating – economic global growth is faltering, earnings are pointing down.
So, there are a lot of factors for which we should be cautious on the market. At the same time, on the other side there are central banks that have taken dramatic U-turns.
We are heading to something that perhaps we haven’t seen before, and these experiments are pre-emptively easing the monetary conditions. So, this is quite puzzling for an asset manager, and it’s a puzzle in the sense that all indicators suggest to stay cautious but industry assets continue to rally and to perform. I think it is to a certain extent affecting the sentiment of investors, so it’s not an easy environment for asset managers.
William Martinez, Aberdeen Standard Investments – In terms of the mood, there has been, I think, a contrast between the external and somewhat stale perception with some poor press, which you could describe in many cases as somewhat disingenuous, given that no one genuinely expects multi-asset to keep up with equities in strong bull market periods.
Nevertheless, there has been this portrayal, and coverage of aspects like outflows. But actually, in terms of a more current view, looking at the multi-asset investment team I work with, we are seeing flows stabilising, performance picking up noticeably, with over the last six to nine months (since late 2018) performance in line with our investment objectives; and we are seeing the effects of process enhancements and personnel changes having positive effects. Hence morale is high and the mood is actually upbeat.
The one opportunity I would cite would be the ability to find opportunities in challenging market environments through a broader opportunity set of investment strategies, asset classes and implementation approaches. The one challenge I would cite is convincing clients not to give up on diversification – which might be at precisely the wrong time, given a very uncertain outlook combined with elevated levels in equity and bond markets.
Chris Murphy, Baillie Gifford – When it comes to the mood in the sector, for me it’s also twofold. On the one hand, we have clients who’ve been invested for a long time and are very pleased, particularly those who value protection when equity markets are falling. On the other hand, it’s absolutely not a time of universal support for multi-asset, and those who compare multi-asset performance to equity market performance, particularly in the short term, will understandably raise questions about the merits of investing in multi-asset. But I believe the opportunity is fantastic. That’s because more and more investors will need to invest in multi-asset, DB [defined benefit] schemes continue to mature and de-risk, DC [defined contribution] investment continues to grow quickly and now invests beyond retirement, and there is increasing interest from around the globe. Those well-established funds with proven track records are primed to deliver attractive returns regardless of the environment that lies ahead.
Peter Martin, Medical Defence Union – From more of an asset owner/investor perspective, I would say it really depends on the type of product that you’re invested in.
There are whole gamuts of different types of products for different types of targets, some are very defensive, some are cash plus three, four or five, some are, say, just being capital preservation, so you wouldn’t compare those against long-term equities because they’re not trying to generate an equity retirement.
So, when you say “disappointing against equities”, I think you’re talking about a subset of funds which at the outset said, “We would produce equity-style returns with two-thirds or half the volatility over the long term.” For those types of funds, who sold under that premise, it’s right as an asset owner that you compare them against equities, but over the long term, not over the last couple of years (or months).
Simon Woodacre, Buck – The trouble is what we’ve seen over the last couple of years is a kind of environment that hasn’t necessarily been the most optimal for DGFs [diversified growth funds]. We split out our classifications of multi-asset funds into absolute return, market directional, static beta and illiquids and they’re all going to perform and underperform at different points in time. There has been a lot of negativity in the multi-asset universe and the environment’s been quite subdued over the last year in terms of returns; particularly if you were an absolute return fund and you promised to deliver this all-weather kind of environment over the long term. However, one year of excessive equity market beta, followed by a correction across all asset classes followed by a strong rally isn’t going to be an optimal environment for these absolute return funds.
Tom Wake-Walker, Redington – I realise that we’re split slightly here between asset managers and consultants/asset owners, and I’m quite surprised by the asset managers’ responses to the question on the mood in the market on multi-asset funds.
I’ve been in several meetings recently where certainly the PMs [portfolio managers], when you ask about expected flows into the strategy, they are quite downbeat and there’s a mood of acceptance that flows aren’t going to be flowing into this asset class over the next year or over the next two years. This is due to some of the reasons previously discussed in terms of potentially managers missing opportunities, the environment not being perfect for the types of strategies, but also for the overriding reason that we see at Redington in particular – there are a lot of defined benefit schemes, which are going into an endgame scenario where they’re de-risking.
Funds Europe – How would you describe multi-asset performance over the past one to three years, considering both returns and risk, and how suitably matched to the market and economic environment have multi-asset funds been? Has there been a particular type of multi-asset fund that has survived and thrived the most?
Wake-Walker – We’ve talked at length about the fact that absolute return funds, or as we call them relative value DGFs, have struggled over the last three years, effectively being flat as an asset class. If you group them all together, it isn’t particularly attractive, and we’ve discussed the various potential issues regarding the economic environment which may have caused the issues with sustained quantitative easing and lack of volatility. I think those are potentially contributing factors to that poor performance.
Martin – It goes back to those managers who have stuck to their knitting. If they sold themselves as a product which could produce equity-type returns, with or without an explicit directional, equity bias and they’ve managed to achieve those returns, that’s great. They’ve done what they said on the tin! Other products may have more of a defensive flavour and if implemented judiciously by the investors, which provides some protection for the monies against equity drawdowns, even for a sacrifice of some long-term equity return, that’s more than OK as well.
It’s a question of ‘horses for courses’ and measuring those products against the expectations of what they’ve sold you. I think those have survived; perhaps thrived is another matter for discussion, but for a number of products, they are doing what they said on the tin.
Sandrini – We mentioned absolute return products that have been struggling, while coping with a limited budget of risk after the equity collapse of late 2018. In a sense, funds with a benchmark had an easier task; the presence of a benchmark forced them to stay relatively exposed to risky assets despite the poor visibility of the financial conditions. In a shrinking interest rates environment, some of the multi-asset strategies that have met the favour of investors are certainly the multi-asset income funds. They are distributing 4%-5% per year from coupon and dividends primarily (sometimes they also distribute a part of their capital gains), but at the same time have the potential to appreciate of return.
Martinez – One aspect to consider is the very strong recent performance of risk parity, and similarly of some other types of funds that have high exposure to directional risks, that are reliant on equity beta, often balancing this with allocations to bonds. A question to me is: is this a warning sign given the very elevated Sharpe ratios we have seen in recent periods? How long can we expect this type of performance to last, given that, although equity markets have rebounded strongly from oversold conditions in late 2018, there are question marks around future earnings and challenges as to how equity markets can continue to deliver strong performance? Furthermore, with bond yields now at very low or negative levels, how much lower can these realistically go? These conditions can be acutely challenging for these types of approaches that I have described.
Conversely, multi-asset approaches that have the capacity to adapt and that make use of a broader toolset are likely to produce better results looking forward, in terms of generating returns and maintaining diversification durably, providing they have the right teams and processes in place to understand the market environment and manage their portfolios effectively, often in rapidly evolving conditions.
Woodacre – We are seeing an incessant search for yield and with clients moving further down the risk spectrum into more unknown risks. The funds that have actually underperformed the most out of the wider universe have been the typical completion funds that try and combine various alternatives in a semi-liquid format.
Murphy – The term multi-asset has evolved and grown to encompass so many different approaches that we have discussed, so we should take care to distinguish. Another point I’d make is that we’re talking about active management, so of course there will be some funds that will perform well, and some not so well. Where I can make comment on multi-asset performance is on our approach, which is to manage a truly diversified portfolio across a broad range of asset classes with flexibility to own more or less of an asset class, depending on valuation and on the macro environment. Our fund has delivered on its objectives over the long term. By long term, I don’t mean one to three years – for us, that’s at least five years.
Funds Europe – Equity markets have performed powerfully in recent months with the S&P 500 setting a new record. Does strong equity performance tend to make multi-asset funds appear weaker by comparison? If so, is it fair to compare the multi-asset sector with pure equity strategies?
Martin – If absolute return multi-asset funds have set out their stall, saying, ‘This is what we will produce, i.e. cash plus X%,’ then comparing them against short-term equity performances up or down, I don’t think is a fair comparison.
However, investors will inevitably do that, and there’s always an element of regret risk, that’s just human nature and a cognitive bias, but as an asset owner or pension fund trustee, you should set out your stall, then try and achieve the desired investment objective in a risk-adjusted manner. If the multi-asset funds employed do achieve their stated objectives over a reasonable timeframe, then that is a satisfactory outcome.
Wake-Walker – There are practical issues here as well that certainly we deal with at Redington. Regarding certain multi-asset funds, it’s hard for some of our less financially minded trustees to have a reference point without a benchmark of some type.
The more directional asset allocation DGFs do tend to have some equity beta – having something to benchmark against is definitely necessary for a certain subset. I think what we find is that the vast majority of our clients understand what they’re invested in, they understand they shouldn’t be looking at the S&P 500 over a seven-month period and they should be factoring in other asset classes into their fund comparison.
Sandrini – It’s very difficult today to convince investors that comparing multi-asset funds, specifically DGF, with equity index is not an apple-to-apple comparison. The last decades have proven to be a golden age both for US equities and fixed income investors due to a combination related to strong growth and falling inflation. We estimate that on average, a 50% equity, 50% bond balanced mandate on average has returned an excess of 8% annualised return on average.
Under the current scenario of ample QE [quantitative easing] and the S&P close to a historic maximum, it was difficult to have investors fully appreciating the value of diversification, intrinsic to a multi-asset fund. The future perhaps will be different, with higher volatility, more trading range equity the power of diversification and tactical asset allocation of a DGF fund could be easier to get for investors.
Martinez – Equity markets can be useful as a risk barometer which investors and clients are familiar with and have a good feel for. They can also be used as indicators of the broader market environment to some extent, being aware of the differences that can occur between markets, and in conjunction with other types of indicators. However, equity markets as performance comparators to multi-asset funds are most often not appropriate, given the diversified nature of multi-asset funds, especially over short time horizons.
As an example, and this might come as a surprise, referring to GARS [Aberdeen Standard’s Global Absolute Return Strategies fund]: taking the three-quarters period from October 2018 to June 2019, the performance delivered is in fact above global equities. If equities are up 25% year to date, that can appear great, but if they have been down 20% the few months before that, all you are doing as an equity investor is just breaking even. GARS is outperforming global equities over that period, delivering material returns, but in a much more stable manner, illustrating the value that multi-asset absolute return can deliver in challenging market environments, by limiting the downside and capturing a greater portion of the upside through the flexible use of a broad array of return opportunities. The path of returns is very different to that of equities and short-term comparisons to equities can be misleading.
Murphy – I think we agree around this table that where it’s not referenced in the fund’s objectives, a direct comparison to equity performance isn’t appropriate, but we also agree that it is inevitable that some investors will compare multi-asset performance to equity performance.
We shouldn’t complain too much. Looking back on the past ten years, a comparison to equity markets for the multi-asset investor might lead to some regret, but at the same time, that comparison to equities can shine a very bright light on multi-asset. When equity markets are falling sharply and multi-asset funds hold up well, then a comparison to equities is helpful!
It is interesting to note that global equity markets fell, peak to trough, by more than 5% on 17 separate occasions since the financial crisis. Our fund protected value, performing much better than the falling equity markets, on every occasion. That downside protection is key to delivering returns with smooth performance.
Woodacre – I agree, given the different asset mixes within these funds, it’s not a fair to compare them to equities. However, equity markets are a good component of the metrics you use to assess funds, but it does depend on what the schemes are trying to achieve.
It is therefore good to look at metrics like equity correlations, equity betas, upside market capture and downside market capture, and for us the key balance from those last two metrics (a negative downside market capture) is perfect. It demonstrates the correct asymmetric profile whereby when markets are falling, your fund returns are rising. So, it’s a key component, something to be aware of, but it’s not a fair comparison.
Funds Europe – Is there a role for illiquid assets in multi-asset funds and how are funds being engineered to gain this illiquidity premium?
Woodacre – This is something we actually focus on quite a lot and try to find the funds that are able to provide access to illiquid alternatives in a single solution. Some managers can have a first-mover advantage in the space. Now, the problem we do find is whether managers have the capabilities in-house to assess these asset classes correctly. This is where the risks come in, because it’s easier to construct these funds within the broader range of asset classes, but if they don’t have the capabilities in-house, then we have concerns about the risks clients are exposed to. If there are significant issues with all these underlying investments, such as higher interest rates, significant defaults within private debt or writedowns in infrastructure, do they have the capabilities for correctly assessing these risks?
Murphy – Appropriate management of liquidity is imperative. The underlying assets the fund holds have to match the fund liquidity that’s promised to investors. Most multi-asset funds today offer daily liquidity, so there is no scope for them to own illiquid assets. Many have demonstrated how multi-asset in a liquid form can deliver on our objectives over the long term.
Sandrini – The compression of interest rates has been massive, leaving investors with a demand for income that they tried to meet going down and down the ladder of credit ratings, incrementally buying emerging bonds, high yield bonds and reducing progressively, therefore, the overall liquidity of their portfolios. Certainly today, it is important to find a space for illiquidity premium for institutional and retail investors.
This must be done within a coherent and comprehensive risk management approach. These two categories of investors are subject to different regulations. While institutional investors can consider illiquid investments such as infrastructure bonds, real estate, leveraged loans and private debt, retail investors, subject to the necessity to have a daily pricing, can invest only into a subset of them. Ucits regulation, for example, speaks clearly about the criteria for liquidity that assets investible for mutual funds should have.
Martinez – In terms of the liquidity of assets, we can think of it as a spectrum, and we know that liquidity is not fixed, it is evolving, in terms of investments that are thought of as very liquid and those that are illiquid – this can change. Generally, on one end of the spectrum there are investments that can be dealt on a daily basis in size such as mega-cap stocks; at the other end of the spectrum, things that are only quarterly dealt and cannot be transacted in even relatively small sizes. That said, inbetween these extremes within that spectrum there are some attractive asset classes, niche opportunities or special opportunities, for example, that can be transacted on a daily basis, not in the same size as mega-cap stocks, but nevertheless with sufficient liquidity for diversified asset portfolios, for example. At fund level, clearly it is imperative for the overall liquidity profile and the make-up of the portfolio to be aligned with the client expectations and the ability to redeem.
Funds Europe – How can pension schemes – considering the different characteristics between them (e.g. large versus small; DC and DB) – make the best use of multi-asset funds? What examples of intelligent allocations to multi-asset have you seen, and what are the common mistakes made by investors that consider allocating to this fund sector?
Murphy – We’ve seen our clients invest in multi-asset for a variety of reasons. These include partial de-risking for DB schemes – some investors are attracted by the one-stop-shop exposure to asset classes in a simplified form, which is helpful for schemes with less of a governance budget. We have also seen investment by local government schemes, which require low volatility in light of the pressure of valuations every three years, and we are seeing more investment by defined contribution investors.
Mistakes? So long as investors are sufficiently patient, I haven’t seen any mistakes.
Martinez – Similarly, we have many examples of DB and DC schemes, large and small, utilising multi-asset as part of de-risking or to have more stable returns, and seeking lower drawdowns and lower levels of volatility. Within DC schemes, one approach we see consists in allocating more to growth assets in the earlier stages of an employee’s working life, and then reducing this allocation and increasing the allocation towards safe assets as the employee progresses through their working life. The management of risk at the different stages of that journey and after is actually a key issue, and can have a significant impact on members’ returns, for example by losing out on mean reversion if the portfolio is de-risked or re-risked at the wrong time. As a way to manage this, it is possible to design multi-asset portfolios that have medium levels of risk and that are suitable across the entire cycle, providing the right blend can be determined.
Wake-Walker – From a Redington perspective, I think the fulcrum of the answer to this question is around governance budgets and the potential lack of a governance budget that DC schemes and smaller DB schemes have.
Chris mentioned potentially asset allocation DGFs, with a directional flavour can be a bit of a one-stop shop, but one of the things you really need to be aware of there is the fact that particular funds there have biases which might make the experience uncomfortable for a lower-governance budget DB or DC scheme as well.
Martin – Just focusing on the DC side for a moment, and the accumulation phase. It is fundamentally about the default strategy that is put together (which is where most people end up), and the journey that you expect the member to experience, or perhaps what they will tolerate. Multi-assets funds can play an important role here potentially – if used wisely and at the right time.
And if you remember when NEST [the UK’s National Employment Savings Trust] first started, there was a great deal of focus in encouraging the saving habit, especially early on in the career of people. What’s probably the most off-putting to a young DC saver is that you put your £2,000 in a year and then you look at your benefit statement the next year and it’s worth £1,000.
Sandrini – It’s difficult to generalise. The usage of MA funds from pension schema varies a lot from country to country; it depends on prevailing regulation, from the presence of investment consultants, from their AuM [assets under management] size and ultimately from the goal or objective of the schema (DB or DC). I can say that in countries such as the UK, asset allocation is often a prerogative of investment consultants, hence multi-asset funds tend to be not the favourite choice from DC and DB plans. At the same time, some large organisations in the world, such as Calpers [the California Public Employees’ Retirement System] in the US, tend to sail in a financial world which is getting more and more complicated, delegating parts of multi-asset portfolios to large managers in order to establish partnerships that can help them in taking informed decisions, reducing costs and ultimately managing the risks better.
Woodacre – I think just to echo some sentiments here on DB and DC, there have been some mistakes made in terms of the funds chosen, but it’s about a solutions-based approach. All these are designed with a specific solution in mind. A good example, say if clients had invested in an emerging markets multi-asset fund earlier in 2018 or 2017, you would have been severely disappointed, given the underperformance of both EM equity and debt and the cross-correlation between the two underlying components. But if you’re trying to get access to a growing part of the world, diversification from other elements of your portfolio and access to significant growth drivers, these funds would serve that purpose.
Martin – If those funds are saying they’re absolute return, and they say that this will be in all market environments, then you need to be careful how you market and manage that, because a lot of investors would think absolute return in all market environments means in every single year, I will not see a drawdown.
If there had been mistakes or perhaps misunderstandings, it’s a question of the mismatch with investor expectations to the experience in underlying funds, whereby the marketing has given the impression that you’ll never see a drawdown and then next year, it’s fallen 5% or 10%.
Funds Europe – What are your expectations for the DGF market in the year ahead?
Martin – I think from the investor perspective, there’s going to be a lot more discussion about ESG concerns, climate change, transition to a low-carbon environment, how those managers are taking this forward and how that’s integrated into your process.
Sandrini – We will be still in a late-cycle scenario with rising risk of contraction amid deteriorating macro and financial data. Central banks will be supportive, granting ample liquidity and boosting multiple expansion. Diversification, stock-picking and risk management will make the difference between managers. We expect higher volatility in the presence of still decent returns that will keep the demand for DGF funds still supported. We expect DGF funds to display a better information ratio than equity funds during the next year.
Martinez – We are definitely seeing increasing levels of interest and awareness of environmental, social and governance factors.
We have been doing a significant amount of work to integrate these considerations within our investment processes, at the level of investment strategies or individual positions, but also in terms of our longer-term asset allocations. Some specific questions we have been working on include: how do trends in the environment such as climate change impact long-term expected returns across asset classes? Or in terms of social factors such as demographics, inequality or immigration, as well as governance factors – how do these impact our long-term investment views and specific investments? These types of considerations are reflected in our investment views and decisions, as these factors can have a material impact of the risk and return prospects of an asset class.
Wake-Walker – I see flows being flat at best for multi-asset funds absent some sustained market volatility this year, quite frankly – over the next 12 months, let’s say. I see a limited number of launches in the absolute return space, as investors are chasing those multi-asset funds which, to Francesco’s point, have more of a benchmark focus with high equity components.
Woodacre – There is a tendency for managers to use a blanket-based approach to ESG, whereby they will say, ‘Oh yes, we have ten people here are doing ESG with an ESG specialist assigned to each fund,’ rather than demonstrate examples of where they have practically applied ESG within their process. We had a good example this year with Vale, a metals miner in Brazil whose dam collapsed. For most managers and analysts, their ESG considerations with respect to Vale were fine up until the collapse. Vale passed on all the screens, but obviously this wasn’t enough because of the large loss of life and massive environmental damage. Our approach would be to ask, ‘What was your approach to the disaster and did you do anything differently? Was there anything new in your approach?’ There were some analysts who did see the build-up obsolescence and acted accordingly, but it was in the minority of cases.
Murphy – There is a continuing expectation for managers to clearly articulate how ESG is embedded in their decision-making. Recently we issued our first multi-asset stewardship report, which outlines how we engage with companies on ESG.
The report was very well received by our clients, so I expect more of that type of explanation to clients. From the investment point of view, we’ve seen a remarkable environment in the past ten years. An environment of support from central banks, low interest rates, low inflationary pressures underpinned by strong growth across almost all asset classes. This environment is unlikely to continue indefinitely, and when there is a change, multi-asset will be a valuable place to be invested.
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