Multi-asset  

How to mix and match your multi-asset funds

  • Describe new ways of building multi-asset portfolios
  • Describe the method for calculating the capital market return
  • Identify the ways of achieving true diversity with multi-asset funds
CPD
Approx.30min

This expected level of volatility then corresponds to the volatility bands of our 1-10 risk profiles.

There is also some correlation analysis being performed, but as a basic concept, the expected volatilities for the asset classes, represented within the solution, are driving the risk-rating.

CMA’s across our asset class taxonomy may look something like this:

Asset Class

Expected 10 year annualised volatility

Expected 10 year annualised return

Cash (money market)

3%

2%

UK Government Bonds

4%

1%

UK Index Linked Bonds

6%

2%

UK Corporate Bonds

4%

2%

Global Fixed Interest

8%

5%

Absolute Return

7%

3%

Commodities

22%

5%

Global Property

14%

4%

UK Equity

16%

5%

European Equity

21%

7%

North American Equity

19%

9%

Developed Pacific Equity

22%

10%

Japanese Equity

21%

7%

Emerging Market Equity

27%

7%

Private Equity

28%

8%

The above numbers are for illustrative purposes only and do not reflect the actual CMA’s provided by Moodys Analytics.

A single asset fund invested in UK equities, for example, would have an expected annualised volatility of 16 per cent, whereas, a diversified multi-asset solution with a 50:50 allocation to Global Fixed Interest (8 per cent annualised volatility) and UK Equity (16 per cent annualised volatility), could project a combined annualised volatility of say, 12 per cent and that would position it at risk profile 6 on the Defaqto scheme.

This is obviously an over-simplified example, but it does provide the basic framework for risk-rating.

However, due to asset diversity, simply doing the numbers is dangerous.

As such, we always interview fund managers to get a good understanding of how they allocate within broad asset classes, which may have an effect on our risk assessment.

For example, data may tell us that they allocate to UK Gilts but we need to understand the actual duration of the bonds they hold to provide a clear prediction of future volatility and the associated risk.

The same would apply to equities and we would seek to understand how a manager may be allocating within, say, UK Equities, to understand if there is a market cap bias to small, medium or large cap, which would, again, influence predicted volatility and the Defaqto risk-rating.

Another piece of the jigsaw worth mentioning is the asset class referred to ‘other’. 

This is present in all data services across our industry and occurs when the data vendor is unable to classify certain assets within the available asset classes, or the fund manager has provided insufficient information to classify those assets.

It’s not unusual to see allocations of 10 per cent or more to ‘other’ but Defaqto takes great care to understand the nature of these assets – exposure to fixed interest assets compared to equities would have a big impact on the expected future volatility and associated risk-rating.

We then undertake reviews on a quarterly basis to ensure managers are continuing to run their solutions in line with our earlier assessments.

Different risk-rated solutions

One thing to note here is, that advisers should not mix and match risk-rated solutions and risk schemes. 

For example, if a fund is risk-rated as ‘5’ by Defaqto that will not equate to a risk profile ‘5’ on another provider's scale. 

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. Why are advisers coming up with two or three risk rated solutions for one investment recommendation?

  2. How does Defaqto calculate its capital market return?

  3. The expected volatility is driving the risk-rating, true or false?

  4. It is OK for advisers to mix and match risk-rated solutions and risk schemes, true or false?

  5. When does recommending several multi-asset solutions to increase diversity work?

  6. What is creating portfolios that use a range of several multi-asset solutions?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Describe new ways of building multi-asset portfolios
  • Describe the method for calculating the capital market return
  • Identify the ways of achieving true diversity with multi-asset funds

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