Multi-assetOct 17 2019

Reducing risk in volatile times

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Fidelity
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Supported by
Fidelity
Reducing risk in volatile times

A multi-asset investment strategy is another way of mitigating risk, in that a fund manager has built in a diversified fund with a range of assets, having done the research already.

So how helpful are these funds really?

A multi-asset strategy can be a very useful way for investors to gain an instant portfolio with one purchase without having to worry about all of the investment decisions that come with building a portfolio, such as how much to have in equities or bonds and whether to own US equities or emerging markets.

In recent years, many more multi-asset investment solutions have become available, which allows investors to select investments that are based on their risk profile, to take some of the strain away from investors. 

Multi-asset portfolios tend to be very diversified across a range of asset classes, such as equities and fixed income, and increasingly alternatives.

Justin Onuekwusi, a multi-asset fund manager at Legal & General Investment Management, says: “If you have just two asset classes – UK equities and UK gilts – your portfolio is going to be a lot more volatile than if you spread your equities over different regions, or if you spread your bond portfolio over different regions.”

Key points

  • It is a good idea to have alternatives in a multi-asset fund
  • Active and passive solutions are available
  • It is best to have non-correlated assets in a multi-asset portfolio

In the alternative space, it is not just about property and commodities. Infrastructure and renewable energy, among others, are proving increasingly popular.

Tihana Ibrahimpasic, multi-asset research analyst at Janus Henderson, says: “These days what you have is a whole host of different instruments, so you can use both mutual funds, active and passive exchange traded funds, smart beta, stocks and bonds and derivatives.

“Diversification across multiple dimensions is what brings that risk reduction. Another thing that is quite important is that multi-asset funds can provide a cushion in those volatile times.

“You are no longer exposed to one asset class, but you can invest across a whole range. At a certain point in time any one of those asset classes will perform positively. That’s the expectation.”

Protection during downturns

The main comfort for investors when it comes to multi-asset investing is the downside protection, particularly during times of large losses, which are difficult to recover from.

Ms Ibrahimpasic adds: “If you think about your standard equity portfolio, if you lose a quarter of your portfolio, it actually takes you 33 per cent of the remaining investment to grow, just to be back at that initial level. This is where the power of compounding works for investing.

“The whole concept of multi-asset investing through diversification is to provide a cushion for your portfolio, so you suffer smaller losses that are a lot easier to recover from.”

In addition, both active and passive multi-asset solutions are now available, giving investors far more choice than before. 

Ryan Hughes, head of active portfolios at AJ Bell, says: “While a small premium is paid for employing someone else to make the investment decisions, for many first-time investors or those that don’t want to play an active part in managing their portfolio, multi-asset funds can play a helpful role.”

But do they actually mitigate risk?

Many multi-asset funds now work to specific targets, which allow investors to invest in a fund that is meant to be more in line with their own risk profile.

Importantly, these multi-asset funds should maintain this risk level over time, whereas historically a cautious fund might have varied its exposure to equities significantly over time, resulting in the risk of the portfolio varying.

By holding multi-asset funds over a typical investment time horizon, the balance between risk and return should improve. It does this by combining different asset classes in a portfolio, such as equities, fixed interest, commercial property and cash, in one fund to provide a diversified portfolio that is supposed to smooth out some of the volatility that comes with investing. 

Mr Hughes says: “As these different asset classes perform well at different times of the economic cycle, it provides a strong natural method of reducing risk. 

“In addition, hopefully high-quality fund managers may be able to further reduce risk and/or enhance return by adjusting their exposures to these asset classes at the appropriate times, to capitalise on opportunities that present themselves in the market.”

When an adviser is trying to build up a multi-asset portfolio, one of the key things they should be looking at is the suitability assessment, to make sure the client is invested in the right place from a risk-profiling point of view.

Ms Ibrahimpasic says that diversification is also very important, and that it is not just a case of having different asset classes, but also looking at their correlation.

Correlating assets

Having a portfolio of different assets that are also highly correlated can expose an investor to losses if those assets were to fall. Ms Ibrahimpasic team recently looked at the correlation between high-yield bond funds and equities.

She adds: “[The correlation] is probably at an all-time high in the past 20 years. What you need to be wary of is the correlation between asset classes.

“They are not constant. If you only hold two asset classes you may not be as diversified.”

As volatility across many markets increases, Mr Onuekwusi says that diversification is going to become even more important.

In an environment where investment returns in all asset classes have been going up since 2009, this means advisers have become overly focused on which multi-asset fund is top of the charts in terms of performance rather than focusing on diversification.

Mr Onuekwusi, adds: “However, I do think we are moving into a period where volatility is elevated and that diversification is going to be more important.”

He warns that advisers need to ensure that in a period of volatility they have true diversification and not take accidental stock concentration.

Over the past 10 years he explains that the focus in multi-asset investing has been more about chasing returns and less about managing risk, a trend that he cautions against.

For example, he points at the growth in stocks such as Microsoft, Amazon, Google and Alphabet, which have been a large driver in the overall performance of the total global equity benchmark.

The four technology stocks now have much larger market capitalisations, and between them they account for a bigger percentage of the MSCI index than the UK. 

Mr Onuekwusi says: “It is really important as we move into this period of volatility that the focus turns back to diversification and risk management.

“The danger is if we just focus on returns and not what is in the portfolio, you simply might not be getting that diversification.”

Ima Jackson-Obot is deputy features editor of Financial Adviser and FTAdviser.com