Getting the diversification balance right

This is because these types of solutions deliver their return objectives by being invested in a range of assets and using the scope of strategies available, delivering their objective as a core standalone fund in clients’ portfolios.

But what does good diversification look like within a multi-asset strategy? How can an adviser know what they are looking at when they lift the lid of a multi-asset fund to look under the bonnet? And is it the case that the more asset classes a fund is invested across, the better?

Tristan Hanson, fund manager of the M&G Global Target Return fund, believes there is simply no such thing as the “right balance”.

To our mind, multi-asset doesn’t mean having a little bit more in bonds, or a little bit less in equities.Andrew Harman

“The term ‘multi asset’ includes such a multitude of approaches to investing – passive, active, tactical, strategic, high beta, low beta, relative, absolute and so on – that, other than the obvious fact the manager can invest in more than one asset class, the term tells you little about the characteristics of a given fund,” he says. 

This is why it is so essential, he confirms, that someone considering an investment in a multi-asset fund understands the characteristics of the fund in question.

Beyond bonds and equities

One thing is certain: multi-asset products have moved on from simply comprising a mix of bonds and equities – or at least they should have done.

Andrew Harman, senior portfolio manager for multi-asset solutions at First State Investments, explains: “To our mind, multi-asset doesn’t mean having a little bit more in bonds, or a little bit less in equities."

If there is no value in government bonds, for example, they shouldn’t form part of a multi-asset portfolio. 

“At the same time, if there is a compelling opportunity, an investor should be free to back it with conviction, rather than doing so halfheartedly because of a necessity to hold a certain percentage in another (less attractive) asset class", he says.

Gary Potter, co-head of the multi-manager team at BMO Global Asset Management, believes: “When it comes to managing a multi-asset portfolio, the essence of a well-diversified and well-balanced solution is to ensure there is sufficient diversification to dampen down the risk of over concentration in asset classes such as equities, fixed income, property, commodities or infrastructure for example, but not to over diversify. 

“If you do all the necessary work, you want to ensure that when your hard work is rewarded with good investment performance its position and sizing in the portfolio is meaningful enough to make a difference.”

He cautions: “On the other hand, you need to make sure that you don’t flood the portfolio with too many components as this will simply dilute the results.”

Correlation

The components of a multi-asset fund may look like it is well diversified, but it could be that in fact all of those assets will rise or fall in certain market conditions.

Mr Harman points out, for example, that the following assets have similar characteristics in stressed markets:

• UK equities.
• Global equities.
• Emerging market equities.
• Listed property.
• Corporate credit.
• High yield credit.

He says it doesn’t matter that one asset might fall less than another, as that is irrelevant for an investor who needs to achieve a specific return to meet their goals.

“Nowhere is this misperception of risk more acute than in the fixed income market,” he observes. 

“Investors tend to think of fixed income as very defensive because that has been the case historically. However, today, parts of the fixed income market have a zero return and don’t seem very defensive at all, particularly in a climate of rising inflation.”

This is why it is so important for the manager of a multi-asset fund to take a flexible approach, shifting exposures as and when they see opportunities to do so and keeping the financial adviser informed of any major changes to the portfolio.

As Kevin Doran, chief investment officer at AJ Bell, puts it: “To build truly diversified investment portfolios, the investment case must be made first with diversification built in using only those asset classes.

“This is most pertinent at the moment in low-risk, cautious portfolios, where modern portfolio theory and rules of thumb lead investors to bond-heavy allocations.”

He warns: “This is despite the risk of bonds doubling in the past 20 years, during which time the expected returns have fallen by over two-thirds. In our view, surely cash and portable alpha strategies are potentially a better option here.”

For better or worse

Mr Hanson reiterates it is not the number of holdings in a multi-asset fund that is important but, rather, how they relate to one another.

For this reason, a well-diversified fund could be one with very few securities or equally it could be one with more than 50 holdings.

Mr Potter notes: “What you are really aiming for is a fund that can take on the rougher times in investment markets by having some more defensive assets, as well as some riskier components that allow the portfolio to generate good returns in the better times for markets.”

He summarises what ‘good’ might look like in terms of diversification: “A good multi-asset solution will have these disciplines at its core, but where a manager is additionally able to nudge the risk up in good times and down when the waters get a little choppier by adjusting the mix of assets appropriately, is also a good feature.”

eleanor.duncan@ft.com