By now, the problem is quite familiar – across the developed world profound demographic change in terms of ageing populations means that demand for income has been growing dramatically.
However, meeting this demand has become very challenging in the low-rate/low-yield environment of recent years. Traditional sources of income – especially retirement income – such as bank deposits, mainstream government bonds and annuities have been offering considerably less than they used to.
People are therefore increasingly seeking income by putting cash in other financial assets such as non-mainstream government bonds, corporate bonds, equities and commercial property. At least the first three of these asset types can directly be invested in fairly easily. However, the evidence suggests that investing in a fund, in which investment decisions and ongoing management of the portfolio are delegated to a professional fund manager, is an increasingly popular option.
In recent years, the mutual fund industry has experienced strong growth. By the end of 2014, mutual fund assets worldwide had reached €28.29trn (£21.23trn) – almost doubling assets under management since the fourth quarter of 2008.
I believe it is no coincidence that there has been such a surge in the use of funds in the years since the 2008 global financial crisis. It reflects significant changes in the way investors approach investing in the aftermath of that extremely traumatic experience.
We have seen a meaningful shift in investors’ aspirations in the past few years. There is clearly now more recognition that some level of trade-off or balance between return maximisation and risk minimisation is a prudent approach to long-term investment success.
Of course, this makes the whole concept of managing an investment portfolio more complicated and time-consuming. This approach demands more than a ‘set it and forget it’ approach. It requires carefully managed diversification and ongoing monitoring and rebalancing of asset allocation decisions as markets move and the environment changes.
Even those with the expertise to manage such portfolios may not have the resources – in terms of time, cost, technology or people – to do so. Delegating this complicated process to experienced fund managers therefore seems a logical step, and I believe this is what has driven much of the mutual fund growth in recent years.
Furthermore, I think it is no coincidence that within those growth figures, the growth of multi-asset funds (with a 63 per cent increase in total net assets from the end of 2009 to the end of 2014) has been higher than that of equity or even bond funds. There is clearly increased appeal for many people in being able to access ‘off-the-shelf’ solutions that enable them to take a more hands-off approach to achieving their investment goals.
Some recent commentary has focused on the prospect of income seekers being forced ‘up the risk spectrum’ in the hunt for more attractive levels of yield than those available on supposedly ‘safe’ assets in recent years. Certainly, investing in some of the assets delivering higher yields, such as dividend-paying equities and corporate bonds, involves taking on varying degrees of financial risk which is an important consideration in terms of a portfolio’s overall risk and return properties. Risk
Diversification (or ‘not putting all your eggs in one basket’) is a well-established way to help manage investment risk. A multi-asset approach offers the potential to combine the advantages of different asset classes, while diffusing some of the risks faced by single-asset class investors and potentially smoothing the journey. However, achieving effective diversification can be a complicated process, requiring significant expertise, time and, often, cost.
Genuine diversification means more than holding a certain amount of each asset class in a portfolio. No asset can be relied upon to behave in a consistent way under every market environment, either in terms of individual assets’ risk/return characteristics, or in terms of how assets behave in relation to each other. Actively managing a well-diversified portfolio is a resource-intensive process.
Tapping into the expertise of established fund managers may offer more than just time and cost efficiencies. One of the greatest risks investors face is themselves – that is; the impact of their own behavioural biases on the decision-making process.
Of course, fund managers are human too, and it is not easy for us to ignore our ‘gut feelings’ either. However, experienced fund managers who follow a disciplined, tried and tested process should be best placed to circumvent their worst enemy – their own irrational impulses.
Other key benefits are liquidity and easy access. Open-ended mutual funds price daily and unit-holders can sell their units back at any time without having to wait for a buyer at the right price, which is not always true of those trying to find buyers for stocks and bonds.
There has probably never been a better time to be a mutual fund investor, given how well-regulated the industry has become in recent years, and the demand for favourable risk-adjusted returns. Furthermore, mutual fund investing can be very straightforward and more ‘direct’ than it sounds. In many ways, mutual funds are the purest form of financial intermediary because there is an almost perfect flow of money between the fund’s investments and investors – excluding expenses, of course. The value of the underlying securities translates into the value of the fund’s units.
*Source: European Fund and Asset Management Association: International Statistical Release, 17 April 2015
Steven Andrew is fund manager of the M&G Episode Income fund
Key points
Traditional sources of income have been offering considerably less than they used to.
The growth of multi-asset funds has been higher than that of equity or even bond funds.
One of the greatest risks investors face is themselves.
