Is the tide turning for multi-asset funds?

But the tide may be turning as investors and advisers alike question the performance of the asset class, the charges that are being levied and the skills of the fund managers.

Ultra-low interest rates among other factors catapulted multi-asset funds – at €198bn (£170bn) – to the number one spot in terms of sales in 2015.

Assets under management ballooned on the back of claims of being able to perform against poor market conditions.

However, market volatility since the second half of 2015 and poor performance from some of the largest multi-asset funds has resulted in a spate of outflows and difficult questions being asked in the financial media.  

With volatility likely to continue into 2017 this is an opportune time for investors to take a step back and evaluate the merits of the asset class.

Multi-asset fund returns in the past 12 months to July 2016 have been largely negative, according to Morningstar data. Looking at asset-weighted average returns over this period, some of the more flexible sectors underperformed more conservative sectors.  On average Flexible Allocation funds returned minus 2 per cent while Cautious Allocation dropped just 1 per cent.  It is interesting to note that the two liquid alternative categories occupied opposite ends of the spectrum: alternative macro being the worst performer, dropping 6.41 per cent, and alternative multi-strategy inching ahead of the pack at -0.4 per cent.

Macro-alternative funds are largely failing on their promise to stay ahead of macro-economic developments. These strategies are hard to implement and difficult to explain to investors, yet the launches keep coming. It is safe to assume that many firms have added a macro-alternative fund to complete their suite of multi-asset offerings without having the requisite skill set – funds should not be launched unless managers are confident of being able to execute them well.

The alternative multi-strategy segment hosts a number of the absolute return blockbuster funds that have failed to live up to expectations, despite the sub-sector being one of the best performers. Standard life’s Gars fund continues to dominate the league table by assets under management (€45bn) but it returned a poor -7.25 per cent (by oldest cross-border share class) over the 12 months to July 2016.

Some commentators have argued that underperformance was the result of ‘wrong calls’  on the US market rather than fundamental issues with risk controls and process. However, size was likely a contributing factor to the underperformance of Gars. While global multi-asset funds have more room to manoeuvre than single-country offerings when the fund is attracting tens of billions of assets it will invariably become less nimble and performance could suffer if there are insufficient checks and balances in place. Size management is critical in order to meet investors’ expectations and avoid reputational damage. 

A number of multi-strategy funds attracted new money. Aviva Investor’s Multi-Strategy Target Return fund returned a more creditable -2.0 per cent over the same period and attracted flows of over €2.5bn during the first half of 2016.  In other sectors there are funds that stand out from the crowd, in terms of both performance and flows.

In Flexible Allocation Flossbach Von Storch’s Multiple Opportunities fund returned an impressive 5.8 per cent during the past year and attracted over €1.8bn in net sales. The manager has a number of qualities that could enable its fund to be the next blockbuster of the European funds industry. It is one of the very few German boutiques with a high quality offering and ambitions to grow beyond the borders of its home country. The manager is on a large-scale recruitment drive and is signing new distribution agreements to help it grow in Spain, Italy and France.

Other funds of note include Nordea’s Stable Return fund which attracted flows of €9.2bn in the past year and returned 6.18 per cent (by oldest share class). Using its international proprietary bank distribution network and strong performance as a springboard, the Swedish manager succeeded in making its fund one of the most popular in Europe, with AUM of €17.3bn. It attracted strong sales in Nordic countries, Southern Europe and Germany. The manager is now attempting to penetrate the UK.

The fund’s investment philosophy has been well-suited to the market environment of the past 12 months as it is based on equities with minimum volatility. The manager needs to prove that its performance will not decline when conditions are significantly different.

Some fund managers have performed well over the past 12 months but have failed attract inflows. A notable example is BNY Mellon’s Real Return, another multi-strategy liquid alternative fund. The fund returned 9.3 per cent but it posted outflows of €670m. JP Morgan Global Income fund (Moderate Allocation) returned 5.7 per cent but suffered outflows of €105m. Clearly performance does not always result in strong sales. 

It is true that performance is much harder to come by these days. Data on balanced portfolios of US equities and bonds (60 per cent to 40 per cent) shows a performance of 14 per cent between 1991 and 2000, 8 per cent between 2000 and 2007 and 6 per cent from 2008 onward. In these deteriorating circumstances managers should be reviewing their charging policy.  Charges are an integral part of performance and will be increasingly scrutinised.  Managers are slowly waking up to that fact and have lowered their charges.

The average ongoing charge for a multi-asset vehicle in the UK market is now 1.18 per cent compared to 1.34 per cent two years ago, based on the relevant categories by the Investment Association. There is reason to believe that charges can drop further still, not only in the UK but on the Continent too. 

In the liquid alternative multi-asset sub -sector the argument that special skills are employed is holding less water these days. Fund buyers acquire these funds based on certain performance and risk targets – if these targets are not met investors will not hesitate to switch to less expensive alternatives. 

Cheaper, more innovative strategies have started to spread within the multi-asset space. Examples include smart-beta multi-asset funds, possibly the next frontier in multi-asset investing. Competition will only start to really speed up in three to four years’ time when products launched today have a longer track record.

Multi-asset funds also face competition from funds of passive funds. In the past three to four years assets have grown to just shy of €20bn by mid-2016. Those multi-asset managers that do not recognise the need for acceptable charges – some are charging unjustifiable performance fees, applied to both rising and falling markets – are in danger of being marginalised.

It is true that when a particular fund or sector has been in the limelight for several years it is not unusual for it to go through a rough patch but overall the asset class has failed its first real test. While a single year is not enough to truly judge performance, and performance alone is not the sole criterion for judging a multi-asset fund, it does serve as an indicator.

Clearly, a number of these funds are highly correlated to the stock market – some by up to 90 per cent - which arguably defeats their purpose.

That said, the prospect for the multi-asset fund industry is generally positive.  Demand will continue – defined contribution schemes are perceived as potential investors – and strategies will shift in and out of fashion.  We are currently seeing a shift in sentiment away from long-only, cautious funds to long-short multi-strategy funds. Another year may see multi-asset back at the top of their game with a new generation of blockbuster funds that charge less, have a robust size-management policy in place and consistently deliver on their targets and risk profile. It is not too much to ask. 

Barbara Wall is managing director of Cerulli Associates Europe

Key points

multi-asset funds have enjoyed record-level inflows in recent years.

With volatility likely to continue into 2017 now is a is an opportune time to take a step back and evaluate the merits of the asset class.

Multi-asset funds also face competition from funds of passive funds.