Mixing it up
Written by Lynn Strongin Dodds
It is no surprise that multi-asset class investing is capturing the hearts and minds of European pension schemes. The current prolonged period of ultra-loose monetary policy, negative real interest rates and volatile equity markets has been challenging for even the savviest of fund managers. These strategies that come in different guises may not shoot out the lights but they can ease the ride in turbulent times.
This perhaps explains why multi-asset strategies were the second best-selling fund category in the UK after equity funds last year, according to the Investment Management Association, while in Europe data from Lipper shows that in the third quarter of 2013, they were the only fund type in Europe where launches outnumbered closures. Although there are various flavours ranging from risk parity to blending different asset classes together, a study regarding European pension fund asset allocation conducted by Mercer showed that diversified growth funds (DGFs) were among the most popular. Almost 20 per cent of the 1,200 European pension funds with combined assets of over €750 billon that were canvassed had allocations to DGFs and the interest is expected to increase.
DGFs are not completely new concepts, having made their debut in the wake of the dot.com debacle, but not surprisingly the ensuing 2008 global financial and sovereign debt crises cemented their role in a portfolio. The difference today is that the list of assets is much longer and includes hedge funds, private equity, loans, real estate, credit instruments, derivatives, fixed income and currencies.
Despite the name, they are not a homogenous group and can vary in terms of their investment philosophy, time horizons and targets. For example, so called static DGFs have fairly stable asset allocation compared to those that look to achieve stable returns and capital protection. There are also funds that employ a systematic approach where risk diversification is at the heart of the strategy. Preference for a particular fund will depend on a scheme’s requirements and funding positions. For example, some may want a totally unconstrained approach while others may be restricted in terms of the instruments and assets they are able to invest in.
Meeting market conditions
Their main selling point is that they aim to deliver equity-like returns over the medium term with lower risk. “One of the main benefits of DGFs is not just the broader opportunity set but the different drivers of returns they can capture,” says Insight Investment senior portfolio manager, multi-asset strategy group, Steve Waddington. “These funds are able to smooth out returns because they look to deliver their return objectives in a whole range of market and economic conditions.”
“One of the most important factors is a robust and transparent investment process,” adds Waddington. “We start by considering three major areas – valuations, economics and market positioning – which means also being aware of what others are doing in the market. For example, look at recent events in Ukraine or the better than expected economic data from the US - these will each present different opportunities for us to generate returns.”
BlackRock vice president, multi-asset investment strategist, Matthew Bullock, also stresses the importance of being able to dynamically rebalance a portfolio according to market conditions. For example, in March, the BlackRock Euro Dynamic Diversified Growth Fund increased its allocation to developed market equities, as well its exposure to European utilities, and created a bespoke basket of UK domestic equities. It also added Taiwanese equity options as downside protection in the event of a sell-off in Japanese equities as the two indices are highly correlated. More recently it developed a customised basket of Chinese equities to gain exposure to sectors it believed were growing and removed those that had lost their shine. This cannot be done by simply buying into an index.
“The challenges of DGFs,” according to Bullock, “are to ensure that investors understand the way these funds operate. They are not designed to capture all of the upside so that when stock markets are very strong, they won’t achieve the same level of performance. However, their purpose is to generate longer term consistent growth, much more consistent than equities, to take advantage of opportunities and trends, and to implement a level of downside protection to minimise investor losses in periods of market volatility. Education is key to ensuring investors have a good understanding of how these products operate.”
Although gaining traction, DGFs are not fashionable in all European institutional quarters. Some are just getting to grips with breaking away from the traditional balanced 60 per cent equities and 40 per cent bond fund. “In the past continental European pension schemes preferred selecting single asset classes but the various crises have made them realise they need to be more proactive,” says Russell Investments France multi-asset portfolio manager Alain Zeitouni. The development of multi-asset class strategies has become more popular but they are seen as a diversifier and are still only a small part of the total portfolio – around 3-5 per cent.”
Zeitouni explains that multi-asset strategies are often incorporated into traditional portfolios consisting of global, emerging market and regional equities as well as fixed income. “There is increasing use of flexible funds that are DGFs by another name, but we believe that investors need to look carefully at the fund management group.
No one can claim to be an expert in equity, fixed income, alternatives, strategic and tactical asset allocation. It requires competencies across the different parts of the organisation.”
According to Barings head of international sales and business development Andrew Benton, the UK is ahead of the curve in terms of multi-asset class investing. “Within Europe, different countries are moving at their own pace. For example, Irish, German and Scandinavian schemes are farther ahead than the Netherlands in incorporating multi-asset investments into their overall strategies. However, without doubt there is an appetite for more stable growth assets with lower volatility than equities across European schemes.”
Barings Euro Dynamic Asset Allocation fund manager Christopher Mahon adds: “Themes are the same as the UK strategies in terms of delivering equity like returns with lower risk but there are nuances. The portfolio is constructed specifically to reflect the needs of European clients. This results in less currency hedging being needed, saving costs. It also allows the choice of slightly different instruments, such as the German bund to diversify global equities, and German property is being used to introduce some European inflation protection.”
Another variation on the multi-asset theme is investing in a stand-alone multi-asset alternative fund alongside the established equity and bond portfolios. “We are seeing people gravitating towards our platform because it is easy and cost effective to gain access to equities and other traditional investment betas,” says J.P. Morgan Asset Management portfolio manager in the global multi-asset group Bob White. “However, this is not the case with an asset class such as private equity or other complicated areas where there is the potential of added value or high barriers to entry.”
According to White, it is important when constructing a multi-asset class portfolio to do it in relation to the core portfolio. There also needs to be transparency, he says, “because one of the biggest issues when a fund outsources is determining the governance around the total fees and monitoring the amount of liquidity”.
Lynn Strongin Dodds is a freelance journalist