The diversification search continues on for investors

This article is part of
Multi-Asset Supplement - March 2014

Many of the multi-asset funds available for retail investors are still run this way, but the past decade, in particular, has given rise to funds that have diversified into other products.

This has mainly meant assets such as commodities or property, generally through funds rather than investing directly, but it has broadened out into other areas and now they have a huge variety of assets and financial instruments to invest in.

A particular favourite among multi-asset managers in recent years has been infrastructure investment trusts.

These trusts, which buy up infrastructure assets and then return the rents on these assets as a regular yield to investors, have proven very popular for investors looking to generate an income in the environment of low interest rates that the western world has experienced in recent years.

Another alternative product for a multi-asset fund to invest in is a hedge fund, but increasingly retail multi-asset products are using the weapons traditionally associated with hedge funds, derivatives, within their own portfolios.

The growth of ‘absolute return’ vehicles has been a big driver of this move, as managers see derivatives as one of the best ways to achieve a positive return for investors whatever the market conditions.

The prime example is the £19.8bn Standard Life Investments Global Absolute Return Strategies (Gars) fund, which uses various derivative-based positions.

An example of a trade recently initiated by the fund is using financial instruments called ‘swaps’ to bet that US and Japanese government bond yields will rise while European yields will fall.

It uses a ‘swap’ to pay for a ‘fixed rate’ 10-year European government bond but receives a ‘floating rate’ bond, which will rise or fall depending on the country’s interest rate. The reverse position has been taken in US and Japanese bonds. The idea is that the difference in the price movement of the fixed rate bond compared to the floating rate bond should deliver returns.

Other derivative-based positions favoured by multi-asset managers include ‘futures’, in which the manager commits to buying an asset at a pre-determined future date and price, or ‘options’, which are similar but without the obligation. So the buyer of the option can choose whether to buy or sell a certain asset at a certain price in the future.

The Gars fund has grown to a huge size because it has succeeded in generating consistent returns in varying market conditions. But it is extremely unlikely that individual investors who have bought into the fund, or even many financial advisers invested in it, truly understand each of the positions and how they work.

This has led some advisers to shun such products, opting not to invest in anything where they cannot fully understand where all the returns are coming from.

Meanwhile, another approach to multi-asset investing has been devised by ex-Hermes manager Steven Grahame, in conjunction with Brooks Macdonald. Mr Grahame’s new fund, the North Row Liquid Property fund, is set to invest in property in a multi-asset way.