Multi-asset teams have a real but obvious advantage over single-asset-class investors as it means they can allocate capital to more attractive areas, as well as reducing risk through enhanced diversification. But these extra return levers also increase their accountability.
This investment latitude and ability to deliver returns in all market environments has led to another development: multi-asset investors are now increasingly aiming to deliver more investment certainty to their clients.
They are now solution providers or outcome-driven managers, designed to deliver investment precision in the form of targeted returns or high income, or both. For diversified growth funds, as an example, we regularly find unambiguous fund objectives such as cash plus 5 per cent over three-year rolling periods, with two-thirds the volatility of equities.
In addition, for multi-asset income funds it is even more exact: a strict goal of 5 per cent income, year in and year out, regardless of where bond yields are.
As we have discussed with many multi-asset managers, we admire this intent – to align the outcome of a fund with what matters to a client. But in the same breath, we also worry that these goals have become too certain and too high.
First, is a form of certainty attainable in financial markets? Can many, disparate moving parts (asset classes) be combined flexibly, such that they deliver regular return precision?
Our view is that diversification does not in itself remove all investment risk such that the probability of future returns changes from a range of outcomes to a single one. This seems common sense to us, more than anything. Hence we struggle to see why targeted returns are always so well defined, rather than in a flexible range.
Second, the targeted outcomes are usually very high. We have already commented on why multi-asset income funds targeting an income of 5 per cent may force them into investment compromise territory. They have to take liquidity and credit risk in quite high doses.
Equally, diversified growth funds target tough goals, often over rolling three-year periods. They usually aim to deliver cash plus 5 per cent regardless of whether markets are supportive or not.
If we assume such moments of poor underlying market returns frequently exist, then during these times they rely on alpha alone. And a regular rolling 3-5 per cent alpha over three years seems unlikely, or certainly unlikely to be repeated regularly.
Our view is that targets are too precise and are probably over stated.
A fund targeting cash plus 5 per cent is probably better suited to stating a return range of cash plus 3-5 per cent. Equally, we suspect multi-asset income funds would be better suited to delivering a yield of cash plus 2-4 per cent.
Perhaps clients wouldn’t buy either strategy, if their competitors had the higher, stretch goals of 5 per cent. And maybe this explains these stretch targets somewhat.
But we think a lowering of return and income expectations is needed within these sorts of funds and this is what we are telling our clients.