Erratic multi-asset flows signal how investors struggle with unusual markets and the promises of diversification. To prosper, these funds must explain themselves better, finds Fiona Rintoul.
Multi-asset investing is not exactly flavour of the month. In the ‘diversified growth fund’ (DGF) sector, funds broadly met their objectives over a three-year period to the end of the second quarter. Although median returns either matched or outperformed relevant performance objectives, there were net outflows in each of the past seven quarters, according to Camradata’s Diversified Growth Funds Survey Q2 2019.
In total, the multi-asset DGFs surveyed (92 funds, equivalent to 66% of vehicles with a track record of more than seven years) lost £20 billion (€22.6 billion) in the year to June 30, 2019. Assets under management are £23.2 billion off their peak at the end of 2017.
Across Europe, in June, multi-asset funds saw outflows of €6 billion – but then inflows of €4 billion in July, according to Efama.
Multi-asset strategies are dealing with an unusual market environment after a decade of ultra-loose monetary policy.
“Equities have performed better and for longer than normal, and diversification has failed to pay off in the way expected,” says David Hutchins, portfolio manager for multi-asset solutions at AllianceBernstein.
However, this bad luck has been compounded by “lack of clarity about objectives” and “flawed design”. The net result is that DGFs – ‘DGF’ is a prevalent term for multi-asset funds in the UK – have disappointed investors.
“A good, cost-effective DGF should outperform a simple composite of passive market components that investors can buy cheaply,” says Hutchins. “By this yardstick, the largest global DGFs available to UK investors have delivered poor value for money over the last five years.”
The unusual market environment has made it hard to beat passive instruments. They have delivered strong performance through the quantitative easing (QE) bull market, says Nick Watson, multi-asset portfolio manager at Janus Henderson Investors, and hinder asset gathering for active managers. He adds: “Client expectations for long returns remain elevated, particularly given starting valuations across a wide range of asset classes.”
Problem of definition
This helps to explain why some multi-asset funds appear to have promised the Earth: equity-like returns with bond-like volatility. In this regard, some managers draw a distinction between two parts of the multi-asset universe: ‘absolute return’ and ‘total return’. It is in the former segment that Hani Redha, portfolio manager at PineBridge Investments, sees a problem of definition.
Marketed as a replacement for equity investing but with a lower-than-equity volatility, absolute return products can perform long/short and relative value trades and are very tightly risk-managed, says Redha. By contrast, total return products – which is what PineBridge Investments offers – don’t short and are more directional. They also promise equity-like returns but accept a higher level of volatility.
Absolute return products have not achieved their typical target of inflation +5% that they promised investors, says Redha. And he contends that, with their tight risk management, a more realistic goal for these products would have been inflation +2%-3%. “They are more like a bond replacement, but that’s not the way they were marketed, and clients have funded them from their equity exposure,” he says.
But, of course, 2%-3% above inflation or cash just doesn’t have a very sexy ring to it. In fact, under 10% of the multi-asset products surveyed by Camradata seek cash with an added return no greater than 3%. Over 50% seek somewhere between 3% and 5% over cash, while around 20% seek between 5% and 7% over cash.
But no good ever came of promising something you can’t deliver. In many ways, the main lesson from recent experience in the multi-asset segment of the market is to say what you do, and do what you say.
“We believe it is axiomatic that DGF managers should ensure a clear link between the investment objective, expected asset class returns and proposed asset class weightings,” says Hutchins. “Rigorous risk-monitoring and adherence to clearly stated guidelines should also be central.”
Right clients, right time
However, it is important to note that not all multi-asset funds have seen net outflows. In the Camradata report, LGT Capital Partners tops the inflows table with net inflows of £406 million in the second quarter of 2019. Also in the top five asset-manager inflows table were DWS, HSBC Global Asset Management, Threadneedle Asset Management and Baillie Gifford. Watson suggest that these companies may have benefited from some of the losers.
“Arguably there are many funds that offer a similar process or approach, in which case the differentiation between funds comes down to delivered outcomes and client service,” he says.
Client service and distribution are perhaps particularly important in the institutional marketplace. There, accessing the right clients at the right time is crucial. “Without both performance and distribution buy-in, it is hard to gain traction in the marketplace,” says Watson.
In some cases, client service is reaching new levels. Alongside the smaller pension fund clients that are typically associated with multi-asset funds, Redha reports new relationships with larger pension funds and sovereign wealth funds at PineBridge Investments. The motivation for the clients is often ideas generation.
“They take those best ideas and use them in their own portfolio,” he says.
The relationship then becomes more of a strategic partnership. This means clients feel they are getting real value added. There isn’t pressure on fees, but there is a need for the excellent client service that Watson alludes to.
“It’s an intensive relationship,” Redha says. “A weekly call in some cases.”
This may be part of the future for multi-asset fund managers. But the question remains: how can multi-asset funds better serve their clients in future in terms of their investment strategy?
Redha is not alone in blaming excessively tight risk management for disappointing returns from multi-asset products – or, to put it another way, risk management not suited to the prevailing market conditions over the past decade. In many ways, this is a question of flexibility.
“DGFs generally were too inflexible to add equity exposure in a market that rose in a very low-risk manner,” says Hutchins. “They also failed to allow for prevailing equity market risk being way below historical norms.”
That was then; this is now. And it is perhaps a dangerous moment to talk about taking on more risk. After all, it is only in a full cycle that multi-asset funds truly come into their own. People have been calling the end of the cycle for a while, and with central banks remaining supportive, it may still be a way off, but it must surely be closer than it was.
“Investors have long understood the market environment would become increasingly difficult to navigate moving forward,” says Christian Lehr, product specialist at Nordea Asset Management. “To adapt to the challenges, investors have needed solutions able to deliver returns, as well as provide diversification and control risk.”
For Nordea, the answer is to look beyond asset classes and exploit risk premia. The idea behind this is that investors are not compensated for investing in asset classes but for the type and amount of risk they take. Nordea typically considers more than 30 risk premia across all asset classes.
“All of them are continuously monitored and tested to ensure our portfolios at all times are running with the most attractive combination of risk premia,” says Lehr. “This investment approach has shown resilience in times of market turmoil, in periods where solutions aligned to more traditional investments have struggled to deliver on objectives.”
PineBridge Investments looks at the situation another way by considering “function”. Bonds are not in the portfolio simply because investors should own bonds, says Redha. They are there to fulfil a function. Similarly, equities are supposed to provide growth, but other assets can also fulfil that function, including new ones. One that is on PineBridge’s list is mid-stream energy, which means energy infrastructure, such as gas pipelines.
“I don’t think anyone else is targeting that as a dedicated allocation,” says Redha. “That’s one way we can add value where the big boys can’t.”
Time to get real
It is perhaps also a question of investors getting real about what multi-asset solutions can and cannot do. After a ten-year bull market, that could be a hard but necessary lesson.
“Genuine multi-asset solutions, as offered by DGFs, provide clients with an actively managed solution to navigate uncertain and volatile markets,” says Watson. “Further growth, however, is reliant on many investors dampening their expectations for future returns, given the starting point of elevated market levels and stretched valuations across a wide range of conventional asset classes.”
A lot of the disappointment with multi-assets has been down to false expectations. It is therefore essential that investors ascertain whether a proposed solution is focused on the specific outcome that they seek – and that providers ensure transparency.
“Given the challenges, we think DGF providers with deep resources, a wide skill-set and a repeatable investment process are best positioned to take advantage of the broad flexibility offered by the multi-asset universe,” says Hutchins.
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