To participate in financial markets is to take risk and, by and large, the risk is rewarded over long periods by a return that is commensurate with the magnitude of the risk you take.
That is to say, if you invest your capital in equities rather than short-dated, government-insured securities, such as gilts, you can expect a higher pay-off over the long term.
But along the way you should anticipate a far bumpier ride and moments where your capital may decline considerably.
Imagine, then, I offered you an opportunity to beat equities without taking much risk at all.
Over the next 15 years, for example, the maximum drawdown will not breach 6 per cent, and your ride will be so smooth it will equate to a volatility of less than a quarter of equities.
What would you think? I know what I would think – it’s time to call the FCA and report a scam.
But that is precisely what has happened in the past 15 years: UK gilts have done just that. UK financial markets have broken the inherent laws of markets; a stark decoupling of risk and return.
Asset classes that carry less risk have handsomely beaten risky assets such as equities. Since June 2001 UK equities have performed worse than gilts and corporate and high-yield bonds.
The 10-year picture is similar. It may seem an obvious point, but worth reiterating, that bonds have no growth, unlike equities. This capped upside is precisely why the risks are lower too, but yet the bulk of capital growth is sitting in bonds and not equities over an extended period.
Why should this concern investors? Funds that have participated in this market anomaly have done disproportionately well and we think that these sorts of market outliers reverse over time.
Funds that have participated in this market anomaly have done disproportionately well and we think that these sorts of market outliers reverse over time. Rory MaguireFor example, UK corporate bonds have beaten UK equities across one, three, five, 10, 15 and 20 years, with less than a third of the volatility and well under half of the drawdown.
Funds, such as targeted absolute return or multi-asset income vehicles, are potentially looking like magic-bullet funds because low-risk assets have done the improbable: delivered equity upside without taking anything like equity risk.
Perhaps high yield, the mainstay of so many multi-asset income funds, deserves a special mention.
If you put £100,000 into both the UK High Yield Bond and the FTSE All-Share indices 15 years ago, today you would have £536,000 and £204,000 respectively. The high-yield allocation would have achieved more than double the return, with less than half the risk.
It is no surprise that the return, income and drawdown statistics of many multi-asset income funds look so good. But have they built their track records during times when markets have been perfectly suited to them? We think the evidence is overwhelmingly strong to support this.
Going forward, we worry about investor expectations and whether they expect multi-asset funds to continue to deliver equity-like returns without taking equity-like risk. After all, an income target of 5 per cent is what equities have delivered for more than 100 years.
For those of us who believe in market cycles, we suspect that an income of 5 per cent today involves equity- and not bond-type risk. Caveat emptor.
Rory Maguire is managing director of Fundhouse
