A tumultuous June in capital markets has served up a timely reminder that markets can go down as well as up – and that all markets can move in line, leaving few places to hide.
The story in June was all about Greece and China. European politicians dallied and dithered, and the Greeks said no, then maybe, while the banks remained tightly shut in the now long-running drama of its debt crisis. In China, a sustained bull market fuelled by cheap credit finally ran out of steam, leading to panicky mom-and-pop investors selling up, and trading intermittently being halted on the mainland exchanges.
The net result of all this for UK investors was that equities and bonds fell in line with each other for most of the month, and while some equities did worse than others (in particular China) nowhere was safe, with the exception of cash or cash-like investments.
Smoothing out the bumps
It is months such as this that can tempt long-term pension investors to consider the merits of ‘clever’ multi-asset funds that are designed to smooth out bumps in the road not just through diversification, but also by assiduous portfolio management.
It has become fashionable for auto-enrolment default funds, Sipp investors and even large institutional investors to use multi-asset funds (also known as absolute return and diversified growth funds) in an attempt to capture long-term growth for less risk than can be achieved through a static asset allocation. But is this the right approach, or would long-term investors be better off simply riding out June-like squalls?
Be careful what you wish for
Many multi-asset funds have been marketed with the suggestion that they are designed to achieve the same growth levels as equities (or near to them) over the long term, but for significantly less risk.
The way they do this is by moving in and out of different assets classes, capturing the momentum of each asset class as it gains favour. Some also use derivatives extensively to reduce risk, a bit like a hedge fund.
It was really after the 2008 Lehmans-inspired sell off that these funds made their name, with many demonstrating the successful ability to navigate choppy waters and preserve value while all else was falling around them.
As a result, achieving returns with low volatility has been the goal of many of these funds which have been running annualised volatility of around 5 per cent ever since, while equities have offered more than twice this level of volatility.
This has become, then, a very low risk investment approach. And while it did well in the down markets of 2008, it has significantly underperformed stock markets in the bull markets that followed.
The argument proposed was that clever portfolio management would allow the funds to deliver equity-like returns for a fraction of the risk. They have kept their promise to keep volatility low, but the returns have been low as well.
This story does mean that the concept of managed multi-asset funds is faulty for long-term investors. It just reiterates the old adage that risk and return are related; if you take more risk you should expect to receive more in return. If you take less risk, as many of these multi-asset funds have, you should expect less in return.