Why diversification matters for multi-asset investment

As Eugene Philalithis, portfolio manager of Fidelity Multi-Asset Income, says: “Saving for retirement is clearly a big potential area for multi-asset funds.

“Advisers can use multi-asset funds to provide a tailor-made solution to their client.”

This works in both the saving and the spending stages – and the sort of strategy employed might depend very much on the client, Mr Philalithis says.

It’s very important to look at the track record of multi-asset funds and where returns have come from. Bill McQuaker

For example, he explains that an equity multi-manager fund might be a good choice for younger investors, as they can afford to take higher risks further from retirement, or “advisers can adopt a target-date strategy, where the asset mix is automatically adjusted as the end savings date approaches”, he says.

What’s driving returns?

How the fund works for clients is often down to the choice of underlying asset by the fund manager, and the reasons behind those choices can determine which sort of multi-asset fund might be right for your clients, especially those approaching retirement.

Therefore, one of the first things an adviser should do when considering either putting together a multi-asset portfolio, or especially when outsourcing the multi-asset decision-making to a third-party discretionary fund manager or multi-asset fund manager, is to understand where historic returns have come from.

Bill McQuaker, portfolio manager for the Fidelity Multi-Asset Open Range, says: “It’s very important to look at the track record of multi-asset funds and where returns have come from as it could have done well by being long equities and credit over the past few years, riding on the tails of the bull market.

“But this won’t be any good if they don’t have other sources of return or can protect on the downside in the future. The next few years will be a good test for the multi-asset industry.”

Someone using multi-asset for retirement might not want to be riding the tail of a bull market, preferring more stable, less exciting returns and a fairly predictable income stream.

In their book The Little Book of Market Myths: How to Profit by Avoiding the Investing Mistakes Everyone Else Makes, authors Ken Fisher and Lara Hoffmans hit the nail on the head.

They write: “History is never pristine. The world can be a pretty darn scary place – there’s never a dull moment.

“If you’re waiting until things ‘calm down’ to be invested, you’ll be waiting a long time indeed. And if you didn’t invest during periods of turmoil, you wouldn’t spend much time invested at all."

The point is, none of us can correctly time the markets, let alone predict what markets are doing.

This is why diversification – to avoid buying on the highs, selling on the lows, losing everything on one asset class or failing to achieve expected income because the bets were too bearish – is the order of the game for multi-asset funds.

By diversifying among complementary valuation-driven performance drivers, a smoothed outcome can be achieved to provide peace of mind and enhanced outcomes. Dan Kemp

Adrian Gaspar, multi-asset investment specialist for Prudential Portfolio Management Group, comments: “Diversification and risk management can be particularly important for those who have remained invested through income drawdown.”

Matthew Phillips, managing director at Thomas Miller Investment, says diversification is an “obvious pro” when it comes to using multi-asset funds.

He explains: “Diversification mitigates some of the investment risk and hopefully ensures a smoother ride in retirement.”

Dangers of too much diversification

However, this diversification needs to be done sensibly, and advisers choosing a multi-asset fund for their pensioner clients need to make sure there isn’t diversification going on just for the sake of it.

Indeed, too much diversification for its own sake can prove to be detrimental. Mr Phillips adds: “Diversification can also dial the returns down. It will dilute the returns from a more concentrated portfolio and one needs to understand how the fund is going to achieve returns and importantly the costs.”

Costs are an essential factor to consider when it comes to selecting a diversified fund. Too much diversification and an adviser should question the manager about trading costs.

Dan Kemp, chief investment officer for Morningstar Investment Management, says: “The total portfolio outcome is imperative. By over-diversifying, a multi-asset solution will hug the benchmark and create unnecessary costs.”

Goldilocks situation

So what should advisers be focusing on when it comes to putting together a multi-asset portfolio – or choosing an appropriate one – for clients in retirement?

Mr Gaspar says: “The focus should be on using scale, true global diversification, uncorrelated assets and any other mechanisms available to try and limit losses if markets fall.”

Mr Kemp agrees: “By diversifying among complementary valuation-driven performance drivers, a smoothed outcome can be achieved to provide peace of mind and enhanced outcomes.

“Valuation-driven diversification helps investors stay the course and avoids the ‘investor behaviour gap’ that causes investors to sell amid panic.”

According to Fidelity's Mr McQuaker, rather than patching together a portfolio that is diversified for the sake of it or simply trying to target a particular level of risk, it is the insight and judgement of advisers and managers that is of most value to the end investor.

He explains: "Risk targeted isn’t necessarily the best option, as it depends what people are looking for. But it is easy to understand. People can fill out a questionnaire on their attitude to risk, with their preferences then mapped onto an appropriate portfolio.

"While that’s powerful in terms of making investing intuitive, it isn’t necessarily a panacea. Investors will always care about returns and there is no substitute for insight and judgement."

simoney.kyriakou@ft.com