Multi-asset funds promise private clients a smoother ride

Multi-asset funds, which have long been promoted by asset managers as a core diversified investment product, are finally coming of age, as shown by their remarkable growth in Europe last year.

Even private banks, which have traditionally opted for individual funds to construct client portfolios, priding themselves on their asset allocation skills, have seen a growing demand for these multi-asset and often multi-manager solutions.

“Multi-assets have become increasingly popular with clients,” states Lars Kalbreier, global head of mutual funds and ETFs at Credit Suisse.

Especially during 2008 and early 2009, mixed assets products have been able to weather the storm much better than pure equity-based solutions, and their lower volatility has reassured investors, he says.

“Volatility is something clients tend to ignore in a bull market, but the memories of the financial crisis are still fresh in their minds,” says Mr Kalbreier, adding that 2008 “was a real game changer and has increased the relative attractiveness of multi-asset funds.”

Their self-proclaimed ability to smooth market bumps is very appealing today, where potential policy and geo-political risks are expected to generate higher volatility.

Fear and inertia have left investors sitting on cash and many have chosen multi-asset funds to regain exposure to more risky assets. “People are suddenly realising they are happy to trade off performance for reduced volatility,” says Jake Moeller, Lipper’s head of UK and Ireland Research. “The market is a lot more conscious of drawdowns now than it was in 2006.”

Of the different types of multi-asset funds, outcome-oriented strategies are most in demand. “Be it an income target, wealth preservation or inflation protection, outcomes resonate much more with an end investor, as most investors invest with a real life goal in mind,” says Tony Stenning, head of UK retail at BlackRock. These products offer much more certainty in terms of a path of return, and allow investors to sleep well at night, he says.

Compared to the old balanced funds, investing mainly in equities and bonds, a wider range of asset classes are included in these products, such as commodities, real estate and, to some extent, infrastructure, provided they are liquid, transparent and scalable.

“The use of alternative sources of return has grown greatly over the past five years and, given the high inter-connectivity within world markets, is only going to increase. Particularly if you want to ensure greater consistency of income, you need to be able to utilise many more levers than previously,” says Mr Stenning.

The Ucits regime has enabled managers to increase derivative usage for efficient portfolio management. Multi-asset funds are also benefiting from the greater choice and flexibility offered by passive products, such as ETFs, to provide more cost-effective solutions. This is particularly important in an regulatory environment where costs are being made more visible to investors.

This coming together of a number of factors seems to have helped managers to align portfolios more with clients’ needs.

“There has been a growing recognition that outcome-oriented absolute solutions are what asset managers should be able to put together in order to truly engage and deliver what their clients really want,” says Christopher Nichols, investment director at Standard Life Investments. There is a clear and sustained move away from the more conventional balanced, historic-type approaches, towards more modern styles, especially those that have very broad investment freedom, he says.

 “It is the benchmark free, absolute return type multi-asset portfolios that are gaining more assets and are accelerating.”

However, he explains breadth of investment freedom needs to be constrained and controlled, and a range of risk-based constraints are used to ensure “the portfolio maintains a high degree of diversity through time and is resilient to market stresses”.

The firm’s flagship Gars (global absolute return strategies) fund, aiming at delivering a return of cash plus 5 per cent with limited volatility, (lower than an equity strategy), has grown consistently to gather $54bn (€39bn) from around the world since launch in 2006.

In the current environment, Lombard Odier also advocates the importance of an asset allocation based on risk, as opposed to capital, and has recently launched a couple of new multi-asset funds based on this approach, LO Selection Vantage 1500 and LO Selection Vantage 3000. They target respectively cash  plus 2.5 per cent and cash plus 5 per cent, with a maximum drawdown of 5 per cent and 10 per cent.

The traditional capital-based allocation strategy, say 40 per cent equity, 60 per cent bonds, is suitable in an environment where equity returns are expected to be high, such as in 2009, “when the risk premium from all the asset classes was pretty generous,” says Stephane Monier, chief investment officer of Lombard Odier’s European private banking business. But today, based on valuations, equities are on average expensive.

“Traditional approaches can over-expose investors to equity risk and may not be dynamic enough to cope with today’s markets,” says Mr Monier.

For this reason, and because different asset classes perform in different phases of the cycle, Lombard Odier builds portfolios whose risk budget is equally split across five key risk factors of inflation, duration, credit, equity and emerging risk, which  correspond to commodities, sovereign bonds, corporate bonds, developed equities and emerging equities respectively. The funds use both passive and active approaches with a mixture of external managers and the firm’s own strategies. They also actively look for uncorrelated sources of returns, which are today found in Ucits versions of hedge funds, managed by third party providers.

“Clients realise they have a certain tolerance to risk and when that is exceeded, they become emotional and take very extreme decisions, such as cutting all risks, and then they don’t recover the losses fast enough,” says Mr Monier. “Having been through several financial crises, investors have become more sophisticated and understand the value of risk adjusted return much better than they did at the time of the internet bubble.” 

Ongoing suitability

Regulation such as RDR (Retail Distribution Review) in the UK may prove a “further catalyst to a number of trends that were already in place”, as BlackRock’s Mr Stenning puts it, and not a key driver to the growth of multi-asset funds. However, together with Italy and Germany, the UK was the country where multi-asset funds received the most inflows last year, according to Lipper.

During the first quarter of this year, sales into multi-asset funds accounted for nearly a third of all net sales according to figures from UK Skandia Investment Solutions platform, product provider of Old Mutual Wealth.

To comply with regulation, which has banned trailer fees, advisers must recommend funds suitable to their client’s attitude to risk. So what they are looking for is a “light touch solution” – one that is suitable to the client’s risk profile and will remain so, such as risk-targeted funds.

 “The focus on suitability and ongoing suitability has certainly led to a plethora of risk profiled funds,” observes Justin Onuekwusi, multi-asset fund manager at Legal and General Investment Management.

While a number of providers are entering the market with what are perceived to be merely repackaged asset allocation funds, the key idea is that the new generation of risk rated funds should help prevent portfolio drift, so that the risk characteristics stay more consistent through time.

This would avoid what happened during the crisis, where a number of balanced funds, labelled as cautious, fell more than pure equity funds because of increased correlation between asset classes.

Clients can get access to both impartial, independent analysis of the riskiness of their funds, as well as the manager’s own expectations. While volatility is a measure of risk, other risks, such as illiquidity, active manager or the drawdown risk are not captured by it, but need to be taken into account, and some can only be assessed on a qualitative basis.

In the Netherlands, a similar version of RDR is also driving the growth of risk profiled funds. More generally, European regulation is moving towards better understanding the risk of each strategy and therefore towards risk profiling. 

Multi-asset funds in portfolios

In the multi-asset space, outcome-oriented strategies are high on the recommendation list at Credit Suisse, because they allow better management of clients’ expectations, explains Mr Kalbreier. Income is what clients demand most, along with wealth preservation, and the bank recommends a handful of multi-asset funds, a specific product for each individual outcome.

“Many clients use this type of asset allocation fund as a kind of bedrock in their portfolio,” says Mr Kalbreier, explaining that key investment themes, such as US technology stocks or Chinese equities, are then added on top. While any client, regardless of their level of wealth, can invest in these solutions, in the ultra high net worth space the level of granularity is higher, he says, and building blocks are generally used to create bespoke solutions.

At UniCredit Private Banking,  multi-asset funds are generally offered to clients served on an advisory basis, whose assets are not big enough to be spread across a number of funds. In general, for larger clients with assets managed on a discretionary basis, the bank uses ‘pure’ funds for each asset class, says Manuela D’Onofrio, head of Global Investment Strategies, Private Banking Division at UniCredit.

In Italy, multi-asset funds have become very popular, especially last year, leveraging on the innovation of asset classes, which today also include volatility, currencies, or alternative assets, says Giordano Lombardo, group CIO at Pioneer Investments, the asset management arm of UniCredit Group.

Multi-assets are the best way to draw retail investors to equity, he says. This is important in a long-term investment strategy perspective, because it is through the most risky assets only that investors earn risk premia. “Portfolio management techniques have evolved a lot and the instruments available to us are today very different from what we had 10-15 years ago,” he says. “Portfolio managers can implement today a number of hedging and protection structures to smooth market volatility.”

In these multi-asset products, the tactical asset allocation component must not be dominant, warns Mr Lombardo. “If the added value of the multi-asset products is simply based on market timing, it would be a very poor product.” The diversification strategy should be structurally stable and the manager’s added value is then to select the best securities and to manage the asset allocation in the best possible way.

Multi-asset products are also most suitable for keeping regular contact with the client, he says, as they provide the adviser with many opportunities to meet the client and explain the changes within the fund, which tie with the developments in the financial markets.

At Banca Fideuram – the Italian bank which distributes its products through a network of 5,000 independent advisers and is part of the Intesa Sanpaolo banking Group – inflows today are going mainly towards “extremely diversified products”, states Gianluca La Calce, recently appointed chief executive officer of Fideuram Investimenti, the bank’s wealth solutions provider.

Their benchmark products, called Core,  are proving popular, managed in-house and investing in a number of underlying third-party managers, and are widely used in clients’ discretionary portfolios. “When building a portfolio, you need to be able to make some forecasts, and therefore we use these actively managed products which have a rather stable diversification structure,” he says.

The Italian firm, which delegates the management of a number of asset classes to third party managers in areas outside its core capabilities, has awarded two asset allocation mandates, with no benchmark constrains, respectively to Pimco and Franklin Templeton over the past  18 months. A similar (growth) mandate was given to BlackRock more than three years ago.

While inflows into these delegated funds of funds had been “very positive” until six months ago, Pimco and Franklin Templeton in particular have been suffering of late both in terms of performance and because of clients’ perception of risk on emerging markets, on which both these asset managers have a very strong, positive view. The bank’s advisers have also reduced their allocation to these funds as a consequence of in-house investment guidelines, which recommend a cautious position on emerging markets, in particular local debt.

Diversification is more important than ever today, but it is paramount to be able to build more efficient portfolios to generate better returns, by also broadening the range of asset classes used, including for example alternative or ‘smart’ beta, maintains Mr La Calce. He also aims at improving techniques of fund and manager selection, to be able to identify “emerging talent” – ie managers that are at the beginning of their value creation process – through the development of knowledge management, and by improving the method of generating and sharing ideas within the firm.