In terms of fund flows, that meant money moving into the Targeted Absolute Return sector like never before. And the bulk of this money was into multi-asset absolute return funds – products that invest across a range of asset classes in an attempt to achieve a positive return in all market conditions.
Investor sentiment may not always be as negative as it was in 2016, but the data show that the success of Standard Life Investments’ (SLI) Global Absolute Return Strategies (Gars) fund was not a one-off. That fund has amassed more than £25bn in retail assets since launch in 2008; rival versions launched by former SLI employees – the Aviva Investors Multi-Strategy (Aims) and Invesco Perpetual Global Targeted Returns (GTR) ranges – now look well on their way to doing something similar.
For advisers, it all makes for an increasingly crowded landscape. Alongside the traditional balanced funds of old, they now have products managed to a particular risk or volatility target, unconstrained portfolios with the flexibility to invest across the market spectrum, and the absolute return variants which attempt to do likewise while limiting downside risk. Multi-asset has become not so much a one-stop shop as a whole high street full of different outlets.
A new solution
Set against a backdrop of advisers’ growing interest in providing a simple solution for their smaller clients, there are two other factors behind this proliferation of products: an attempt to learn the lessons of the past, and the aim of avoiding making new mistakes in future.
In the aftermath of the dotcom boom, multi-asset strategies had already begun moving on from the relatively fixed weightings to bonds and equities that characterise balanced funds. But the financial crisis brought a repeat of risk assets’ mass underperformance and accelerated a desire for products that delivered an absolute outcome rather than a relative one. After all, minor index outperformance is of little use at a time when that benchmark has fallen 30 per cent.
The greater flexibility touted by many newer products is also a reflection of a longer history. The 30-year bull-run for bonds, traditionally the safe asset of choice for a diversified portfolio, has left managers wondering what happens when fixed income goes into reverse. Enter a portfolio that is more adaptable but run to particular risk limits.
Andrew Cole, co-manager of the Pictet Multi-Asset fund, has been running similar portfolios for more than 15 years, largely at former employer Barings. He believes the concern over bonds, while justified, may have resulted in some multi-asset funds being used for the wrong purpose.
“The fact that some providers have increasingly sold their product on the basis of its risk constraints means they will have a different type of client base – people owning it as a bond replacement rather than an equity replacement.”
Part of the problem is that, for all the benefits of diversification and go-anywhere portfolios, there simply may not be any assets that have the same risk characteristics as bonds once did.
But Scott Gallacher, chartered financial planner at Rowley Turton, suggests: “A lot of [funds] are trying to use weird and wonderful structures to replicate the risk-reward characteristics of [bonds], and they can do to some extent by stripping out duration risk. They are not necessarily trying to give clients the best return, but they are trying to produce a modest return.”
Mr Cole’s answer is to acknowledge that more risk must be taken.
“We have notionally moved up our risk budget. We think that at some point we will have to take a bit more risk than we advertised previously. I think that’s an appropriate answer; most investors require returns rather than something that is risk-free.”
Correlation game
The idea of moving up the risk scale is complicated by the fact that suitability reports are never far from an adviser’s desk. In any case, the question to ponder, then, is just what role multi-asset funds serve in a portfolio.
With so many options available, it is perhaps not surprising that a study produced by the portfolio research and consulting group (PRCG) at Natixis Global Asset Management also found potential discrepancies in the way that advisers use multi-asset products.
The study showed that a majority of multi-asset allocation funds used in advisers’ model portfolios replicated those parent portfolios in terms of both correlation and overall performance.
The survey was conducted in summer 2015 but the findings remain broadly applicable, according to James Beaumont, head of the Natixis division. He notes that using funds in this way may make sense, but only if advisers are aware of the role they play.
“Multi-asset funds can often give ballast to a portfolio. We tend to talk about risk-reducing assets on one hand, and return-enhancing assets on the other. Multi-asset as a rule of thumb doesn’t fit into either camp: they tend to fit in the middle and perform like ballast,” Mr Beaumont says.
Another consideration to be wary of is the fact that these funds frequently appear to be much of a muchness. The typical “moderate” portfolio, defined by Morningstar as having an equity component of between 35 per cent and 65 per cent, has a correlation of 0.79 with other moderate portfolios, the PRCG research suggests. The assessment is based on a correlation coefficient in which a score of ‘1’ is equivalent to a perfect correlation.
The allocation funds in question tend to mean the older type of multi-asset product, but Natixis has also called into question the way that multi-asset alternatives are viewed.
This definition encompasses the absolute return funds which have found such popularity recently. These portfolios typically do away with the multi-manager style used by older multi-asset funds in favour of direct investment into a range of assets and derivative strategies.
Mr Beaumont says these funds are less diverse than some may suspect. He points to similarities with advisers’ own model portfolios.
“The issue we sometimes see with clients who use multi-asset alternatives is that they think alternatives equal diversification, which is not always the case. If you looked at [this kind of product’s] correlation to a UK adviser balanced portfolio, it would typically be over 0.5, 0.6 or 0.7.
“We think anecdotally [buyers] are expecting correlations in alternatives to be below 0.5, probably nearer zero or 0.2 to 0.3.”
This, at least, is a lower correlation than that observed among more traditional multi-asset products, according to Matthew Riley, head of research at the PRCG.
“Allocation funds have a higher correlation to portfolios than alternatives. The latter are better than allocation funds in providing diversification, they have a bigger toolbox, but they are not as good as you might assume,” Mr Riley explains.
Head-scratching
The continued existence of assumptions such as these, several years on from the launch of Gars, does raise questions over whether advisers truly understand multi-asset absolute return products.
Anxious to avoid anything even faintly resembling the mis-selling scandals of yesteryear, the regulator is also taking a closer look at how investment products are described and marketed. The FCA set up a specialised division at the end of 2014 to scrutinise retail funds “from cradle to grave”. Publicly, the division has been relatively quiet since then, but it continues to engage with providers as they bring products to market.
When it comes to multi-asset absolute return, those same providers are also stepping up their own efforts to inform advisers of exactly what their funds aim to achieve.
Aviva Investors’ multi-strategy products – Multi-Strategy Target Return and Multi-Strategy Target Income – have seen a combined £3bn in inflows this year. It seems a safe bet that a large proportion of this money has come from advisers, but the asset manager claimed earlier this year that intermediaries’ lack of knowledge of the funds is a “continuous problem”.
The asset manager is now launching training sessions to better explain its products – for example, their ability to short assets or leverage up – to advisers.
The sessions are split into three parts. The first seeks to “demystify” derivatives by explaining a handful of techniques, from swaps and options to more complicated concepts. The second is a simulation, which gives users the chance to bundle together a number of strategies, over different time horizons, in an attempt to achieve an attractive risk-adjusted return. The third considers how multi-asset may fit into a broader portfolio.
Jeremy Leadsom, head of wholesale at Aviva Investors, says: “We launched Target Return in 2014 and we always intended to take training out into the marketplace. Right from the start, we felt intermediaries needed help articulating the multi-asset strategy.
“I have been in the industry since 1991. People say ‘balanced fund’, ‘multi-asset’, and so on, but they need to be aware of the differences.”
Performance
Ultimately, all multi-asset products will be judged on their performance. Long-term comparisons are difficult because many of the newer products, by definition, have only been launched in the past three years.
But Table 1 shows that even those that have been around longer have not managed to trump the traditional products on a three-year view. This is in large part because of the strong performance of both equities and bonds over that time frame.
Even most of those traditional products have struggled to match the performance of Vanguard's passive LifeStrategy products in recent years - leading a recent report from FinalytiQ to suggest there is "no evidence that multi-asset managers' asset allocation and fund selection expertise is worth paying for".
So why the shift when it comes to fund flows? It is, in part, because many advisers do not believe the past few years will prove an accurate predictor of the challenges that lie ahead.
Barings’ Mr Cole acknowledges: “Managers, ourselves included, have been flattered by the risk profile of our funds over the past 10 to 15 years. Bonds have given a big slug of equity-like returns [despite inherently being] an asset that is a lot less risky.”
Typically, the products which have been so popular of late aim for a mid-single-digit annual return, over a rolling three-year period, with half the volatility seen in the equity market.
This year, these types of products have underperformed all four mixed investment sectors, as well as benchmark equity market indices such as the S&P 500 and FTSE All-Share. Asset managers will say this is because stocks have continued to perform well – absolute return products do not intend to match indices when returns are surging. But there have been signs the products can also struggle at times of market stress.
Gars, for example, under-whelmed in 2016, losing 3.5 per cent as of 20 December and prompting some ratings agencies to effectively downgrade the product. The fund was removed from FE’s approved list of funds in September, having also attracted criticism from Morningstar during 2016, but the fund house is sticking to its guns.
SLI has previously said in response to those decisions: “In the last year, Gars behaved as we would expect in terms of risk, providing investors with low levels of volatility and drawdown relative to risk assets, but returns were disappointing due to our long-term investment views being markedly different from the short-term factors that have frequently driven markets.
“Periods like this have occurred before in the history of Gars and by sticking to our process and philosophy, while adapting to changing underlying drivers, we are confident the fund will resume its upward path.”
As the standard bearer for this type of product – and one in which a significant amount of client money is held – Gars is scrutinised more closely than most. It has underperformed relative to peers in 2016, but it has not been along among multi-asset absolute return funds in experiencing drawdowns during difficult periods for risk assets, as Table 1 shows.
This performance data highlights that the absolute return sector is home to some higher volatility products. Separately, there are also worries about how lower volatility funds, such as Gars, have dealt with scenarios in which fixed income struggles. These concerns may bring to mind the worry voiced by Mr Cole – and shared by Natixis – that low-volatility products are inaccurately viewed as bond replacements.
In any case, multi-asset’s ability to deal with a bond slump may be tested again in the new year, particularly if developed economies start to shift to tighter monetary policy and inflation starts to pick up. Early evidence of these two trends helped spark a fixed income sell-off at the end of 2016.
This is the kind of environment in which advisers may suffer if they automatically assume that the newer strategies can protect them from this kind of problem.
This time round, however, absolute return funds have coped reasonably well so far. Gars, GTR and Aims have all held up well since the bond slump began. Traditional multi-asset funds, too, have performed well – not least because their dwindling bond holdings have been offset by a rally for equity markets.
Planning ahead
The question is how all of these products will perform in a situation where bonds and equities go down in tandem. In that scenario, there may be little place to hide for even the most flexible product – particularly as no outcome-focused product launched since 2008 has ever had to face a real bear market.
One solution may be to look to the handful of funds that tend to move inversely to risk assets. There are products new and old which meet this criterion – it may be of note that, among 2016’s uncertainty, both the Troy Trojan multi-asset fund and the Jupiter Absolute Return fund saw sizeable inflows (see Table 2).
Rowley Turton’s Mr Gallacher says: “We as a firm use complementary and contrasting funds – ones that work together but also do different things at different times. The aim is to construct diverse portfolios for clients, tailored to risk profiles. That way you hopefully avoid betting on one outcome.”
Whatever the merits of the latest cohort of multi-asset portfolios, Jerome Nunan, investment director at Aviva Investors, acknowledges that the newer breed are unlikely to fully replace existing multi-asset portfolios.
“The vast majority are going to run traditional multi-asset funds and outcome funds in tandem. There is a capacity limit around [our multi-strategy offerings] of £40bn; there is no way we could replace the current demand for multi-asset with that. There isn’t the capacity in the market [either].”
One outcome, which may materialise, according to Natixis, is a gradual shift among advisers to a whole range of more complex strategies – not just in the multi-asset space.
Mr Beaumont says: “The way people invest in alternatives changes the longer they’ve been invested. If you’re going to invest for the first time, the safest option from the point of view of an adviser’s investment committee is multi-asset alternatives. But once people have invested for two to three years, and become more comfortable with alternatives, then they can start to learn about other strategies.”
If that is the case, advisers truly will have access to a wider range of investment strategies than ever before. But there are two caveats of which they are very conscious. Firstly, absolute return remains a relatively untested investment strategy. On top of that is the very real problem of explaining these strategies – and other alternatives – to clients. In keeping with the sector’s own philosophy, a prudent approach would be sensible.
