Does the turbulence hitting stock markets at a time of rising bond prices mean it is time to ditch multi-asset funds?
British institutional investors have enjoyed something of a love affair with multi-asset funds in the past 10 years, a period where it has frequently topped the Investment Association’s list of most popular asset classes.
The strategy continues to be a cornerstone of UK institutional portfolios. The share of multi-asset mandates as part of the overall UK institutional market stands at 24%, up from 21% two years ago, according to the Investment Association. Since the introduction of automatic enrolment, growth has mainly been driven by. asset class’ popularity has been mainly driven by defined contribution (DC) schemes, which incorporate it into their default strategies.
Multi-asset funds appeal to the DC market because, unlike final salary schemes, which are in de-risking mode making capital preservation a priority, they want a low-governance income strategy. Yet while inflows into the asset class have grown since the beginning of the year, the performance of the UK’s largest funds has been far less appealing. This raises the question whether investors are still getting a good deal.
Looking at the long-term performance of some multi-asset funds distributed in the UK, it is easy to see why investors consider them as an appealing alternative to single asset mandates. The core idea behind multi-asset is to benefit from the negative correlation between bonds and equities to offer investors relatively less volatile returns.
Multi-asset funds have benefited from the best of both worlds as unconventional monetary policies have pushed prices higher for bonds and equities, whilst inflation remained relatively low. Consequently, several multi-asset funds generated double digit returns, making them a more attractive investment proposition than some hedge funds.
Yet the flipside of that occurred at the beginning of this year, when equity and bond prices fell at the same time. One catalyst for that was a gradual uptake in inflation across many developed markets, which in turn is having a negative impact on fixed income returns whilst also raising the possibility of central bank rate hikes.
In theory, such a market environment should point towards stronger economic growth and hence buoyant equity markets. Yet this link is far from straightforward, as the experience from the first half of 2018 shows.
This year opened with a strong bout of equity market volatility, which saw the FTSE 100 record its largest drop since the UK voted to leave the European Union in 2016.
At the beginning of February, the FTSE 100 fell by 2.6%, wiping £50bn off the index in a single day. At the same time, gilt yields continued to rise amid growing speculation that the Bank of England was on the verge of hiking interest rates. A similar trend was evident in the US and across Europe, where falling stock markets coincided with falling bond prices, leaving multi-asset funds to face a double whammy.
Bonds and equities have recovered from these temporary shocks, yet the performance of most multi-asset funds continue to reflect the effects of such a turbulent start to the year. For example, Fidelity’s £775m Multi-Asset Income Fund’s standardised performance dropped to -0.5%, compared to a 11.7% jump in the previous year, according to Morningstar.
Similarly, Investec’s Diversified Growth fund’s standardised performance was at -5.6% over the past year, compared to a solid 8.5% the previous year, while the standardised performance for M&G’s Episode Allocation fund dropped to +1.29% from +19.17% in the previous year.
The fact that performance challenges have affected multi-asset funds across the board suggests that the problems for multi-asset might be linked to structural changes in the global economy, rather than to problems with individual fund managers.
Institutional investors have certainly taken note of these challenges for multi-asset. One example is Lloyds Banking’s pension scheme, which recently swapped a diversified growth fund in favour of a full equity allocation as part of the entry level phase of its DC default fund.
Across Europe, net sales of multi-asset strategies dropped to €23bn (£20.4bn) in the second quarter 2018, compared to €89bn (£79.1bn) in the previous three months, according to the European Fund and Asset Management Association.
Philip Kalus, managing partner at European fund distribution consultancy Accelerando Associates, stresses that the merits of multi-asset should be assessed on a case-by-case basis.
“Multi-asset funds have been a mixed bag,” he says. “A number of prominent UK multi-asset funds have been suffering for quite a while, GARS (Standard Life Aberdeen’s Global Absolute Return Strategies) being the most prominent example. The current macro environment has been particularly hard for the more defensive funds. “Multi asset is really about getting the macro bets right and a lot of fund managers got it wrong at the beginning of this year,” Kalus adds.
For Alan Pickering, chairman of BESTrustees and a trustee of several DB and DC pension schemes, the key question for multi-asset investors going forward is whether the increase in correlation between bonds and equities is a one-off or part of a long-term trend.
“We use multi-asset strategies to provide diversification,” he says. “All trustees who are using them are now reviewing their merits as we are seeing a reduction of the distortive effects of quantitative easing. “There may well be disappointment looking at the performance of some funds throughout the first quarter, but the key question is whether the fund performed as you would expect it to perform given the market environment.
“In pensions we are investing for the longterm and we have to avoid media reactions to specific market events,” Pickering adds. “It is worth keeping in mind that every time we change our asset allocation we incur costs and in DC land, those costs are directly transferred to members’ portfolios.”
Ana Cuddeford, multi-asset investment director at M&G Investments, also stresses that investors should consider the performance of multi-asset strategies over the longer haul.
“Our investment process aims to identify opportunities that offer attractive risk-adjusted value. “We also look to capture opportunities that arise from episodes where investors’ behaviour pushes asset prices away from what we see as ‘fair value’. When episodes occur we often find ourselves taking contrarian positions.” Cuddeford points to early 2016 as an example when the team bought global mining stocks, bonds and Japanese banks. Later in the year, around the time of the US election, it added exposure to Mexico. “Taking this long-term approach is a significant part of how we aim to achieve our funds’ longterm performance,” she adds.
Indeed, looking in more detail at multi-asset fund performance throughout the second quarter, signs of improvement are tangible, as Sean Thomson, managing director at Camradata, highlights. Looking at the performance diversified growth funds in particular, he stresses that in the second quarter of 2018, three quarters of DGFs in the research firm’s universe reported moderately positive results. “Over a longer time span these funds have nearly all rewarded their investors,” he says. “According to the three-year spread of annualised returns, 99% of DGFs in the database achieved a breakeven or positive return.”
Yet the question remains whether the increase between bond and equity correlation could become a longer-term problem affecting multi-asset performance. Andy Sparks, head of portfolio management research at MSCI, is sceptical. He argues that the effects of rising correlation on the common 60% equities, 40% bonds strategy would be moderate, unless it coincided with heightened levels of bond market volatility.
Even if correlation levels increased to 0.50, risk forecasts for 60/40 strategies would only increase to 7.7% from their current level of 7.1%, MSCI predicts. “Current bond market volatility is much lower than equity volatility (2.6% versus 11.8%, respectively),” Sparks says. “Bonds indeed still act as an anchor to the portfolio: The low volatility in bonds dampens the impact of a change in correlations on portfolio volatility.”
Added to that is the fact that multi-asset strategies can of course also include other asset classes, as Kalus highlights: “Multiasset is not just about equities and fixed income, strategies such as commodities, cash and niche fixed income strategies all add extra levels of diversification.
“We also shouldn’t forget that we have faced nine years of bull markets, we think volatility is likely to come back,” he adds. “In this context, I wouldn’t dare to say that it is time to sell multi-asset, on the contrary, for DC schemes in particular, it could be beneficial to take on a slightly more defensive stance going forward.”
Pickering also cautions investors, particularly those responsible for DC schemes, against making hasty decisions. “There is a real danger that we may turn against multi-asset at a time when quantitative easing is being unwound and it may become of value as a source of diversification,” he says.