How to construct a multi-asset portfolio for retirement

This is the view of Aviva Investors. A commentary from the company reads: “Rather than narrowly focus on volatility, we believe at the heart of any successful multi-asset solution is a robust portfolio construction process.”

For the Aviva multi-asset fund range, the team focuses on three key elements: strategic asset allocation, tactical asset allocation and implementation, taking each asset’s contribution to risk into account, and stress-testing the portfolios to ensure they deliver consistent client outcomes.

Nick French, head of UK wealth management and managing director for Russell Investments, agrees that a portfolio construction should “help clients stay invested”.

He advocates a multi-portfolio approach, one which can cater to various aspects of a client’s investment strategy, as outlined in another article within this guide. 

Traditionally, as Aviva Investors’ house view explains, multi-asset funds adopted a binary (sometimes tertiary) approach:

• Equities – the riskiest asset class, with greatest growth potential.
• Fixed income (with cash) – typically used to lower the overall risk.
• Alternatives – something that will move independently of either equities or bonds.

However, the team comments this approach is no longer as effective as it used to be, as some fixed income assets, for example, could be riskier than equities.

Instead, the team categorises investments into three categories: growth assets, defensive assets and uncorrelated assets, and each fund within the multi-asset range has an allocation to these three categories.

This offers flexibility for the adviser and for the client, with the necessary diversification. But is this adequate for retirement planning?

Dan Kemp, chief investment officer for Morningstar Investment Management, says: “A portfolio must have a clearly defined objective and should not be dominated by one performance driver."

Flexibility 

David Absolon, investment director at Heartwood Investment Management, believes flexibility is key when it comes to structuring a multi-asset portfolio for retirement.

He says: “For us it is about flexibility in terms of the structure. We have a number of core strategies here which our clients can access via a segregated portfolio or a multi-asset fund, which is essentially just a fund wrapper around the strategy.

“What’s more important is then how you build the multi-asset class portfolio. A lot of people do it differently, there’s no one right answer.”

The important thing is not to pigeonhole all clients into one particular form of multi-asset fund, or to follow just an active versus passive portfolio style for all clients, or a fund of funds.

If clients set realistic goals and are prepared to accept they may lose out on some performance in rising markets in exchange for the potential to limit losses in a downturn, there is a good chance of their long-term aspirations being met. Adrian Gaspar

He explains: “It’s about having this flexibility, rather than pigeonholing yourselves into a portfolio that has to be active, or has to all be collective investments.

“Flexibility is the key.”

Stable environments and no promises

On a cautionary note, Mr Kemp warns against too much turnover of managers when it comes to selecting a multi-asset portfolio for a client.

He says: “Investors want to avoid multi-asset solutions with high turnover. The people, process and parent are very important, as key person risk or a weak parent company could derail an investor’s financial plan. These are much more important than past performance.”

Mr Kemp also believes advisers should be wary of multi-asset funds structured in a way that they offer fixed yield or return targets. 

He explains: “Solutions that promise 7 per cent fixed returns, using covered calls or something similar, or a 4 per cent fixed yield, should be viewed with caution as they may increase the risk of a permanent loss of capital.”

Accumulation vs decumulation

Multi-asset funds can be useful and flexible tools for retirement planning, but they need to work for the investor both in the accumulation and the decumulation stages. 

This is why a focus on the end goal – the client’s desired investment outcome – is vital.

Mr Absolon says: “Returns based outcome investing, as we call it, is the reason why we have four core investment strategies. Each global multi-asset class portfolios but each trying to beat CPI by a different margin over a cycle, and therefore this can capture, we think, the majority of clients who come through our door at certain points in their life.

“And they are fluid and flexible so what’s right for the client in terms of their capital at one point in the cycle for them, may not be in another, so they can move fluidly through what we offer.”

A particular consideration in the accumulation stage, which Mr Absolon said was important for advisers whose clients have garnered high levels of pension saving, is how close to the lifetime allowance (currently at £1m after falling from a £1.8m high in 2010) they are.

He adds: “This is highly relevant for them in terms of what type of return they’re looking for, given the tax efficiency or inefficiency if they’re very close to their Lifetime Allowance. We can tailor that for them as well.”

Smoothing

Smoothing – a term synonymous with old with-profits funds – has its detractors, but the concept of creating multi-asset fund ranges, where the client’s portfolio is managed to ride out the peaks and troughs more carefully and transitioned into arguably less volatile asset classes, such as inflation-linked bonds and gilts, can be attractive as a proposition.

Adrian Gaspar, multi-asset investment specialist at Prudential Portfolio Management Group, comments: “The idea of ‘smoothing’ returns may seem outdated to some.

"However, if clients set realistic goals and are prepared to accept they may lose out on some performance in rising markets in exchange for the potential to limit losses in a downturn, there is a good chance of their long-term aspirations being met.”

For example, in the institutional world, target date funds (TDFs) are being used more frequently.

They are dissimilar to lifestyle funds in that while a lifestyle fund has to transition entire portfolios of underlying funds at various stages for the member, a TDF is essentially a multi-asset fund that is actively managed to transition seamlessly – the so-called ‘glidepath’ - through the member’s accumulation and decumulation stages.

The graph below shows a model target date multi-asset portfolio, based on State Street Global Advisor’s asset allocation strategy.

The blue/lilac, largely equity or higher-risk components gradually decrease as the client nears retirement, while the brown/gold, lower-risk, largely bond components, increase.

The image shows how the various asset class mix is actively reallocated based on the number of years left until the member’s retirement date, which aims to minimise the risk while maintaining diversification across asset classes.

Income diversification

It is also wise to consider structuring a portfolio to create diversified income streams from a multi-asset portfolio.

Matthew Phillips, managing director at Thomas Miller Investment, explains: “It is important to have an idea of where the income is going to come from, and to bear in mind that “income” can come from above inflation capital growth over the longer term.”

Seeing a natural income stream produced by the fund is useful and should at least provide a regular income flow to the individual.

For Paul Ilott, director of multi-asset research at Scopic Research, part of The Adviser Centre, having a carefully structured fund that allows for both growth and income generation, but mitigating inherent volatility, is critical.

He comments: “Multi-asset funds that are managed to an upper volatility ceiling can be one option to consider here.”

Ultimately, as Morningstar’s Mr Kemp says: “A multi-asset portfolio should have a framework for success and have the behavioural ability to work to that framework.”

simoney.kyriakou@ft.com