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Magazine Issues » March 2012

MULTI-ASSET FUNDS: Protection for the future

UmbrellasMulti-asset funds could solve the asset allocation question for a confused workforce in the DC market. But can providers persuade trustees that additional costs are worth it? George Mitton investigates.

Managing the accumulation phase of a typical defined contribution (DC) pension used to be simple: members put most of their money in equities, watched them rise in value and switched to safer assets five or ten years before retirement.

But the past decade, in which equities performed relatively poorly and exhibited high levels of volatility, has challenged conventional thinking.

Some say multi-asset funds could fill the gap. By spreading their investments across a range of assets, including hard-to-access alternatives such as private equity, these funds promise lower volatility and fewer nasty shocks. They also offer an opportunity for scheme members to outsource their asset allocation to investment professionals who can monitor and tweak that allocation as time goes on, maximising returns.

And yet the modern range of multi-asset funds lacks a track record long enough to satisfy some big players. And there is a barrier to widespread distribution: cost.

The idea of a fund that invests in more than one asset class is not new. Balanced funds that invest in both equities and bonds have been around for some time. But the past few years have seen a flowering of innovation. Today’s multi-asset funds are different in the extent of asset classes they target – from real estate to commodities to infrastructure – and the diversity of instruments they use, namely derivatives. Some see these vehicles, which are also known as diversified growth funds, as a way for the industry to offer a more tailored service to clients.

“Multi-asset funds are the best way for asset managers to play an advice role for individual investors, particularly in the DC pension regime,” says Jamie Broderick, head of Europe at JP Morgan Asset Management.

It is in asset allocation that the industry believes it can be of most help, says Simon Chinnery, also of JP Morgan Asset Management.

“Most people would put their hands up to say they don’t want to, or don’t know enough to make their own asset allocation decisions,” says Chinnery, who is senior client adviser in the UK institutional team.

An indicator of how much scheme members dislike choosing their own allocation is the proportion who opt for the default option in their scheme. Prudential says that, typically, more than 80% of members in occupational DC schemes choose the default.

Chinnery says multi-asset funds are about having “an independent or professional body to make decisions of asset allocation on behalf of the defaulted client base”.

The range of multi-asset funds on the market can be incorporated in the life cycle of a DC pension in various ways. Given that most multi-asset funds target equity-like returns, with reduced volatility, they can be a substitute for equity funds in the accumulation phase.

Alternatively, they can be used in the early stages to prevent losses that might discourage members from continuing with their DC pension, or in the late stages, when capital preservation becomes paramount.

There are other possibilities, too. Because they can invest in real assets such as property, multi-asset funds can act as an inflation hedge. Some funds are based on liability-driven investment and seek to mitigate the effect of interest rate changes. Other funds are of the “absolute return” sort, meaning they aim to offer positive returns in all market conditions.

“I think it’s healthy what we’re seeing,” says Chinnery. “Of course, with all these things it may be confusing to the end user so the key is how we translate that into a language that is acceptable and motivational, from the employee’s point of view.”

The perceptions of end users are crucial because multi-asset funds tend to have one important weakness: they are relatively expensive. A fund which invests in multiple asset classes needs enough staff and resources to analyse all those asset classes. If the fund deals in derivatives, it needs staff who understand these instruments and it must pay for the contracts. All these factors add to the fees it must charge.

“Diversified growth funds will tend to have higher costs than a conventional long-only fund,” says Hamish Wood, head of investment sales at Aegon. We offer a number of diversified growth funds as external links, such as the Baillie Gifford Diversified Growth fund and a BlackRock fund, and these funds cost 0.7% above the conventional product charge.”

Wood says that an employer which appointed Aegon to run a group personal pension might be charged 0.5% of its assets as an administration fee, which includes access to default long-only funds and some passive products. Choosing to externally access a diversified growth fund could add significantly to the cost.

This may be problematic if the diversified growth fund is included in the scheme’s default option. Although the employer may value the benefits of the multi-asset fund, if these benefits are not communicated to scheme members, the high charges may be seen as unjustified. “For default funds, where a fund has higher costs, having people automatically invested in that leads to questions,” says Wood.

Intelligent ways
The problem of cost is topical, given that some influential players in the pensions industry are promoting very low-cost solutions. The National Employment Savings Trust (Nest) is a UK workplace saving scheme aiming to encourage new savers. It only charges 30 basis points in annual fees because it focuses on passive strategies. This is partly for cost reasons but also because chief investment officer Mark Fawcett seems to doubt that active managers can add value in mainstream, efficient markets.

Nevertheless, Nest does have a diversified growth mandate as one of its five investment areas, and appointed BlackRock to this role in February 2011.

However, Wood does not think employers should forget using multi-asset funds for their default option. There are intelligent ways they can incorporate these funds without adding too much to the costs. “The trend seems to be that the big consultancies are looking to blend funds,” he says.

“Rather than have all the money go to diversified growth, they would want to create a fund that invests 50% in a diversified growth fund and 50% in, say, a passive equity fund. It’s a halfway house.”

So multi-asset funds are an expensive but useful tool, if their benefits can be communicated to scheme members. But are these benefits real and worth having?

The question rests on whether the asset allocation offered by these funds is the right service for members, and there is a potential problem: the asset allocation of the fund is chosen on the basis of meeting the fund’s target return, and this will not necessarily match individual members’ risk tolerance.

Broderick at JP Morgan stresses that multi-asset funds offer a way for the industry to play an advice role, but it is important to remember that these are collective investment vehicles. They do not offer advice that is specific to each member. Scheme organisers can manage the scheme so that members of similar age groups are treated the same, but this does not reflect the individual preferences of these people.

Cheap allocation
Richard Skipsey, head of platform distribution at Legal & General Investment Management, says that for this reason, he does not view multi-asset funds as the best way for scheme members to get asset allocation advice.

“Advice in my mind is individual. What might be an appropriate risk level for one member might not be for another. Multi-asset funds, at the end of the day, are collective vehicles and therefore the asset allocation advice within them is homogenous,” he says.

“Are they the best way for investors to get cheap asset allocation advice?

They meet some of the challenges but they don’t meet all of the challenges. The challenge is, how are they best used in an overall retirement planning strategy?”

Other industry figures agree that multi-asset funds can play an important role within DC pensions but that they are not a cure-all. They can meet some clients’ needs by providing diversification and dynamic asset allocation. But they do not provide a service tailored to the needs of the individual scheme member.

If asset managers want to play an advice role, there is still space for innovation in products and structures that will allow them to meet individual members’ specific tolerance for risk.

“[Multi-asset funds] can be a sensible move,” says Jean-Baptiste de Franssu, chief executive of Incipit and former president of the European Fund and Asset Management Association. “Look at the Carmignac Patrimoine fund, it’s an asset allocation fund with a long-term perspective, so it does play a role. Is that the only way to do it? No.”

©2012 funds europe