Making the most of
How to use multi-asset funds in client portfolios
Grasping risk is critical to assessing a multi-asset strategy
Schroders has rotated into alternatives in its multi-asset portfolios, Johanna Kyrklund has revealed.
The global head of multi-asset investments for Schroders urged advisers to look "underneath the surface" of multi-asset funds.
Asked how multi-asset managers should be positioned given the economic cycle, she said: "We heavily emphasised equities last year.
"I think a lot of the juice has been squeezed out of that particular orange and we have been rotating into more alternative sources of return which have been performing quite well, even this year.
“So we would emphasise alternatives right now and I think later this year we expect probably to rotate back into bonds.”
She added: "Obviously, bond yields have been rising of late. There could be some interesting opportunities over 2018."
But she acknowledged alternatives as an asset class could mean something different to another multi-asset manager.
Ms Kyrklund said: "I think it is really important to understand the toolkit, particularly when you are looking at alternative assets.
"For example, there has been a lot of interest, of late, in alternative credit which could get quite illiquid in a more difficult market environment.
"So really understanding how much risk is underneath the surface is critical to assessing any multi-asset strategy."
Ms Kyrklund suggested multi-asset funds had an important part to play in a client’s portfolio as a core allocation, supplemented with "high conviction views from the adviser".
Advisers relying on multi-asset funds for diversification
Advisers have said they are typically relying on multi-asset funds to achieve diversification in client portfolios.
The latest FTAdviser Talking Point poll revealed 45 per cent of advisers said they would choose a multi-asset fund for diversification, while 26 per cent said they used them in the accumulation stage of clients investing to grow funds.
Patrick Connolly, chartered financial planner at Chase deVere, acknowledged they tended to use these funds for clients with smaller portfolios, which he defined as sub-£100,000 but certainly for those with portfolios of under £50,000.
He reasoned multi-asset products were an “easier way to achieve diversification”.
Only 5 per cent would select a multi-asset strategy to meet clients’ income requirements, according to the poll results.
Joshua Gerstler, financial adviser at The Orchard Practice, commented: “We do use some multi-asset income funds, mainly to provide a boost to the income streams for certain clients – generally those who take drawdown, or are either getting closer to or are already in retirement.
“Occasionally we will deploy them as a portfolio diversifier if there is an area or asset class that we, or the client, feel is under-represented, but not so much that it justifies using a focused fund.”
Nearly a quarter, or 24 per cent of advisers, said they did not use multi-asset funds at all for clients.
Mr Connolly suggested for those clients with £100,000 or more, he would not use multi-asset funds.
He also questioned whether the products were cost effective and observed while multi-asset funds could be used for ease of administration, advisers needed to “be wary of costs”.
“You get the benefits of a buy-and-hold solution but often that comes at a cost in terms of charges,” he said.
“Funds of funds are often very expensive. It’s not unusual for ongoing charges of over 2 per cent a year.”
Asked why multi-asset funds were such a useful tool for advisers, Mr Gerstler noted that they were particularly useful when a client felt there was an area they could be more exposed to without making a concentrated bet.
“The multi-asset funds on our list invest around the globe through a wide range of asset classes and regions, and afford exposure to these without putting too much emphasis on a particular one, which, if accessed through a more focused fund, might cause the client’s portfolio to deviate from their risk profile and/or needs and objectives,” he explained.
Multi-asset funds have found their way into an adviser’s toolbox of financial planning products.
There has been an influx of multi-asset products into the retail market and the sales figures seem to indicate advisers are using them in client portfolios.
The IA Mixed Investment 20-60 per cent Shares sector topped Fidelity’s FundsNetwork sales charts in the final month of 2017, followed by the IA Mixed Investment 40-85 per cent Shares sector.
Paul Richards, head of sales at FundsNetwork, says it is clear that asset class diversification through multi-asset funds was one of the themes concerning advisory firms and their clients last year.
Top of the picks
November’s figures from the Investment Association tell a similar story.
Mixed Asset was the best-selling asset class in December 2017, after clocking up net retail sales of £1.7bn - as the industry body pointed out, their highest net retail monthly inflow ever.
This brought net retail sales of multi-asset funds to £13.5bn over the past year, with the Mixed Investment 40-85 per cent Shares and 20-60 per cent Shares sectors taking in £2.8bn and £2.5bn in 2017, respectively.
What is prompting advisers to turn to multi-asset funds to meet client needs?
The clue really is in the name, with multi-asset products able to select investments from across the asset classes to meet differing risk and return targets.
As Tony Yousefian, senior research analyst at FundCalibre explains, in this way they can form a core part of a portfolio.
“There are a plethora of different types of multi-asset funds around today, with varying risk profiles, so there will be a number to choose from that are suitable for your client,” he says.
“Once you have chosen the core, you can then let the fund manager do the job of changing asset allocation for you and you can then focus on adding some satellite investments to your clients' portfolios as and when you think appropriate – allocating smaller amounts to sectors, countries or themes that you and your client are excited about or have conviction in.”
Jason Hollands, a managing director at Tilney, agrees multi-asset funds do play a valuable role in a wider portfolio.
“Most multi-asset funds are structured as complete investment solutions to meet a particular goal and risk profile and, as such, they have become core standalone investments used by many advisers.
“This is particularly for clients whose assets are below the typical threshold required for a bespoke discretionary investment account,” he acknowledges.
“As products which now represent the bedrock of many an adviser’s investment proposition, there is a wide range of choice available from both asset managers and discretionary investment managers.”
Doing your homework
Indeed, the choice may be overwhelming.
According to FE Analytics, there are 157 constituent funds in the Mixed Investment 20-60% Shares sector alone, and another 161 in the Mixed Investment 40-85% Shares sector.
Advisers need to do their homework to be able to identify the type of multi-asset fund that will meet individual clients’ financial outcomes.
There are ways to differentiate between the products available.
“The key differences between the plethora of multi-asset funds available are between those which operate within a clearly defined risk framework that typically aims to match the output of widely used risk-profiling tools, and those which are able to take a more flexible and tactical approach to asset allocation, depending on the manager’s view of markets that might involve increasing the risk budget,” explains Mr Hollands.
He lists the three major differences in how a fund implements its investment strategy:
1) A whole of market selection approach versus a fettered fund approach.
2) Whether investment is principally through actively managed funds versus a passive approach.
3) And, increasingly, whether a fund deploys through collective investments or is run on a manager of manager model of handing out mandates to particular fund groups.
Whatever the strategy, all multi-asset funds take the stock selection and asset allocation decisions out of advisers’ hands to some extent, freeing them up to focus on the financial planning aspect of their job.
Mr Yousefian notes: “You [advisers] need to understand the objectives, goals and associated risks of the multi-asset fund but you are choosing multi-asset for a reason - so a professional can do the asset allocation monitoring and changing for you.”
This also removes some of the behavioural biases which occur when clients are left on their own to invest.
Jeremy Greenwood, senior relationship manager at Seven Investment Management, has observed with potential new clients that their investment choices can be very personal.
“Clients may have had a previous good experience with a certain stock or sector and this can lead to a behaviour bias in their investment decisions,” he suggests.
“We see clients holding onto ‘losers’ in the hope they recover some of their former sheen, or having an overweight position in a sector familiar to them, exposing their wealth to unnecessary risks.”
Ticking the diversification box
This can sometimes be a successful way to invest but, more often than not, it is a matter of heart over head.
“It makes sense to invest in investment stocks or sectors that you have a personal interest in, but it is not necessarily the best way to construct a diversified portfolio,” points out Mr Greenwood.
“There’s nothing wrong with having some fun with shares, but it is not the right way to weather-proof your portfolio too.
“It is important to diversify geographically, but also at a sector level too. Multi-asset funds can help diversify risk further beyond traditional asset classes.”
For those advisers who think this means being able to pick a fund and then forgetting about it, they might want to think again.
As with any investment, there is no guarantee the fund will do what it says it’s going to and keeping a close eye on whether it is meeting the client’s objectives will be necessary.
Mr Yousefian believes advisers do not need to understand the rationale behind every single change the fund manager makes to their multi-asset portfolio.
But he concedes: “You will need to review the fund a few times a year to make sure it is doing what you expect and meeting your clients' goals, but no more. Otherwise you may as well do the asset allocation yourself.”
Mr Hollands agrees and adds that some of this responsibility lies with the fund manager and their ability to communicate what they are doing in their portfolio.
“Although multi-asset funds are often positioned as off-the-peg outsourced investment solutions for advisers, advisers using them continue to have the all-important client relationship and responsibility for ensuring ongoing suitability so, understandably, advisers do not want to find they have become disintermediated,” he notes.
“It is therefore important for advisers to be kept well informed by managers on how the funds are being managed and alerted to any major developments in the strategy or holdings so that they are suitably empowered when their clients discuss their investments.”
All this is fairly straightforward and part of the process advisers will be undertaking when choosing any type of fund or investment product for a client portfolio.
Motivated by macro
Multi-asset funds may have risen in popularity due to their cost effectiveness and ease of use for advisers, but the macroeconomic environment has also been a factor in driving investors into these products.
As reported by FTAdviser, there are some potential risks on the horizon: “Strong global market sentiment for risky assets, a weakened dollar and geopolitical turmoil in the Middle East underline the need for a long-term multi-asset portfolio”.
This was according to Tom Elliot, international investment strategist at deVere Group.
Simply having exposure to an equity asset class and fixed income is no longer likely to meet the capital growth or income expectations of many investors now.
Hence the need to be diversified across a range of other asset classes, including alternatives, property and commodities.
Speaking to FTAdviser, Johanna Kyrklund, global head of multi-asset investments at Schroders, says: “Multi-asset funds are strategies which are designed to cope with a range of market environments and they do this, firstly, by casting their net as widely as possible to include a very broad range of sources of returns.”
She explains they do this through a “dynamic approach to asset allocation, really adjusting exposures to take account of the valuation and the economic environment, for instance”.
What’s in store for investors as they navigate the asset class spectrum this year?
In her outlook for 2018, Ms Kyrklund explains she will be seeking new sources of diversification this year.
“Given structurally lower expected returns on many asset classes, we are making increased use of alternatives to diversify our portfolios,” she says.
“These include factor-based alternative risk premia, such as momentum, that can earn positive returns in both up and down markets.
“By allocating actively across return-seeking, risk-reducing and diversifying strategies we believe investors have the opportunity to earn returns, no matter what 2018 brings.”
Focus on alternatives
Jerome Teiletche, head of cross asset solutions at Unigestion, suggests alternatives have played and will continue to play an important role in the performance of its multi-asset offering this year.
“Our overall performance has been achieved consistently with expected contributions from both traditional and alternative risk premia, and from the diversified range of systematic and discretionary strategies run by the team,” he confirms.
“As we move further into 2018, our positioning still favours growth assets over fixed income to benefit from the synchronised growth, but we are preparing the portfolio for higher inflation expectations.
“From our standpoint, the major risk is a stronger normalisation of monetary policy than what the market is currently expecting.”
He concludes: “Furthermore, as valuations are becoming stretched on most traditional assets, we expect our alternative risk premia strategies to contribute further to our performance and focus on relative value positioning.”
There is little sign that advisers’ interest in multi-asset funds and strategies is on the wane.
They are increasingly popular as a core allocation in a wider investment portfolio.
But advisers still need to make sure they know how these funds are allocated, particularly when multi-asset managers are relying on alternatives to achieve stable returns.
In fact, with the uncertainty surrounding global equity markets at the moment, multi-asset funds are likely to be a mainstay of client portfolios for some time to come.
Ellie Duncan is deputy content plus editor at FTAdviser
The house view from Johanna Kyrklund, global head of multi-asset investments at Schroders
For 2018, three is the magic number for a reflationary environment to continue.
1) Growth: we expect global GDP growth to remain at roughly 3 per cent over the next two years. Last quarter, we highlighted the potential for the US Congress to surprise on tax reform and this has proved to be the case but we would fade any fiscally-induced excitement at this point as we don’t expect US companies to fully spend the benefits of their tax cut.
2) US 10-year Treasury yield: based on our models, US equity valuations are sustainable as long as the US 10-year yield does not go above 3 per cent. This would require inflation to remain subdued.
3) Inflation: as we believe that technological disruption and ageing demographics are suppressing inflation, we expect an upper limit of 3 per cent to hold and for the process of monetary normalisation to be gradual. Against this backdrop valuations become a speed limit for returns over the medium term but we think a period of lower returns is more likely than an imminent bear market.
What could upset the apple cart?
The most obvious answer is 'inflation'. One indicator which suggests that growth (and therefore inflation) could surprise on the upside, is that global trade has been picking up.
Another risk comes from wages.
Although wage growth appears to have been unresponsive to tight labour markets so far, research by the Federal Reserve suggests the Phillips curve is non-linear and when the unemployment rate falls below a certain threshold, the relationship between unemployment and inflation will re-assert itself and core inflation will begin to rise.
When we model these two scenarios – 'trade boom' and 'inflation accelerates' – our global inflation forecast rises from 2.3 per cent to over 3 per cent.
From an investment perspective, given market pricing, this outcome would cause volatility in the government bond markets but would also present an opportunity for more cyclically-exposed, value-driven areas of the equity markets to outperform.
A disappointment on the growth front would be more concerning for us.
Developed economies are currently in the expansion phase, which is characterised by output above trend, growth accelerating and inflation rising.
This phase of the cycle is typically benign for equities. The next phase of the cycle is the slowdown phase and this is the worst phase for returns.
The challenge is that, at first, the slowdown phase typically feels alright – output is still above trend and, although growth is decelerating, it is still positive.
But by this phase equity return expectations and valuations are elevated, leaving room for disappointment and negative returns.
Trends to watch
For now the traffic light is still green but there are three trends we are watching:
Firstly, the authorities in China and US are withdrawing liquidity. Although policy normalisation is appropriate at this stage of the cycle, there is always the risk of tightening liquidity too quickly.
Secondly, yield curves are flattening, which suggests that bond markets are starting to price in slower growth. This is somewhat at odds with the optimism reflected in equity market valuations.
Thirdly, our expectation is that the US dollar is likely to remain weak as the rest of the world is catching up with US growth. If we are wrong and the US dollar strengthens, however, this would put pressure on Chinese growth and would tighten liquidity.
All in all, we continue to be positioned for a reflationary environment with an emphasis on emerging market assets which look relatively cheap.
At some point in 2018 however, synchronised global recovery will morph into concerns about synchronised liquidity withdrawal.
The real surprise for 2018 could be that we end the year with government bond yields lower than today.