The current low-yield environment is challenging investors’ reliance on traditional asset classes, such as equities and bonds, and with that the traditional 60/40 portfolio, to provide sufficient returns to meet their investment goals. Here our Multi-Asset Solutions team explore why strategic asset allocation (SAA) may not be enough in markets ahead and how to select an appropriate objectives-based strategy.
We don’t believe that simply holding a large number of asset categories provides real diversification
Strategic asset allocation, while simple in its design and so far successful, has never really considered the retirement phase of investing. As an investor approaches retirement, two things have changed from when they first started saving; firstly they’ve got more capital at risk and secondly, they’ve got a shorter investment horizon. Both of these factors expose the investor to sequencing risk. With that being the case, we don’t think you can rely on long run averages to the extent that we have historically.
As an asset allocator, the ‘holy grail’ is uncorrelated returns. The equity/bond relationship that has served SAA products so well over the past 3-4 decades, is going to become more dynamic as bond yields move to a new regime.
We advocate for uncorrelated return drivers within a portfolio, which reduce volatility and improve investment outcomes. To do this, we must take into account and understand the dynamic relationships and valuations of asset classes. In practice, at times this may translate to not holding expensive and/or correlated assets that won’t add value to the portfolio. The litmus test of true diversification will manifest itself through higher consistency of returns and lower drawdowns for investors.
If we’re going to deal with sequencing risk, we need to remove the handcuffs of the 60/40 or 50/50 allocations and look beyond just adding returns, but more importantly, abating risks.
We believe genuine multi-asset products are the best way to achieve superior risk/reward outcomes, as investors have the broadest set of investment tools at their disposal. That said, having the tools is not enough; we believe you need to be flexible and dynamic to achieve long term sustainable investment goals.
But what is a genuine multi-asset product?
The advent of objective-based investing has provided greater focus on the achievement of specific outcomes, rather than ‘beating the market’. While the proliferation of product offerings has been positive for investors, to the extent that it has provided choice, these funds are not an investable asset class that can be tracked with a passive index; rather they are a standalone product. This means return objectives will vary, which makes any meaningful comparison difficult. Peer universes (i.e. a range of similar products) are being developed, but are hard to define with managers taking different paths to achieve returns and protect investors’ capital. As such, many funds fit the broad definition of a multi-asset strategy. With investors’ focus moving toward achieving specific outcomes the ‘how’ becomes crucial.
The lack of homogeneity in this sector presents an issue for performance comparison. There are two commonly used, although imperfect, comparison practices in the market:
#1 The traditional 60-40 portfolio
There isn’t a passively-investable benchmark that achieves a set return over cash or inflation with low volatility. Investors want the ‘holy grail’ of investment; meaningful returns with low risk. However active management is required to deliver these returns. This has led to performance comparison of the set-and-forget strategy. The fixed 60-40 equity/bond allocation is simple in its approach and can be passively replicated. This comparison misses two important points, though. First, the idea investors are willing, or pleased, to narrow the path of returns, i.e. giving up some of the extreme positive returns for less exposure to negative outcomes. Second, it assumes that investors are willing to bear this level of risk, and the benchmark is appropriate going forward.
#2 Peer groups
Peer group rankings can be useful in comparing active manager performance and risk characteristics. The key essence of a peer group is that they are equal, similar and comparable. The multi-asset investment universe is vast and, to date, it has been difficult to define meaningful sub groups within multi-asset. As a result, large numbers of multi-asset funds with varying strategies are grouped together. This has led to large, all-encompassing, peer universes. From balanced funds that are set-and-forget, risk parity, active total return, non-market directional alpha strategies and everything in between. In some cases it can even include single asset class strategies or a constrained investment universe.
This has resulted in peer universes with hundreds of funds which are not comparable in investment objectives, risk characteristics or holdings.
What to look for in a multi-asset product
We would encourage investors to set out what it is they require from their investment in the form of return, risk tolerance and investment horizon. This will help in matching their needs to a multi-asset offering. The central tenet of objective-based funds was to decouple the path of an investor’s returns from the underlying market’s performance.
Investors should look for:
- A total return objective; this could be relative to cash or inflation
- A stated rolling investment horizon over which to achieve the return target regardless of financial market conditions
- The ability to access a wide range of asset classes and sectors
- Significantly less risk (volatility and drawdown) than equities
We also believe multi-asset strategies should also have flexible product designs which are not constrained by benchmarks or restricted to long-only investment. They must be truly dynamic in their asset allocation to take advantage of market opportunities when they arise across the full spectrum of equities, bonds, currencies and alternatives.
We design our multi-asset strategies to maximise the probability of meeting its investment objective over a stated investment horizon (rolling five years). This doesn’t take into account peer group investment positioning or performance. It also decouples us from a capital market benchmark such as the 60-40 portfolio. We believe this maximises the chance of delivering an attractive investment outcome for our investors.
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