Take the weather with you
Multi-asset funds are often portrayed as being flexible enough to adapt to changing economic climates and market conditions. Sue Whitbread talks to Paul O’Connor and Dean Cheeseman of Janus Henderson’s UK-based multi-asset team, about why they believe that an efficient and robust multi-asset approach is ideally positioned for today’s challenging economic, political and market environment
IFAM: What’s your outlook for a multi asset approach in 2019 and beyond?
JH: We believe that we are moving into an era in which active management becomes more important. It’s an environment in which the multi-asset approach in particular will have a major part to play in providing effective solutions for advisers and their clients. The reason for saying this is that we are now in the late stages of a long-running bull market in most asset classes and late into the period of economic expansion. These conditions mean a much more challenging environment for investors with lower anticipated returns than those we’ve seen in the last decade and for volatility to be higher.
A passive approach works well in a strong phase of a bull market and in a buy and hold environment. It’s different now as conditions are much more choppy. In these circumstances multi-asset has a big role to play. Most importantly, it gives clients genuine diversification, providing a smoother ride during such times. It gives access to active asset allocation too, with an opportunity to rotate within different sectors, as well as giving us lots of flexibility overall as managers; a significant strength in this environment.
We’re well positioned to take advantage of this flexibility too; for example, we could hold a significant amount of exposure to emerging markets at one stage or we could also own zero.
IFAM: Can you give us some detail about your investment approach to multi-asset? How does the team approach work?
JH: There are eleven members of our UK team and we bring three areas of specialisation to all the funds we manage. Each person has to be a specialist in one of those areas which are:
- Asset allocation: some of us will look at portfolio construction. This includes things like the equity/bond breakdown as well as more dynamic side of asset allocation such as when to adjust hedging, how do we react to news items like Brexit etc.
- Manager selection. The role here is to identify the most efficient way to implement our asset allocation ideas and also about extending our opportunity set. It’s about bringing different ideas to the attention of the team. We use the full range of instrument types in all of our multi-manager and multi-asset funds. So, we’ll use Janus Henderson funds, external funds, passives, ETFs, and directly in individual shares too. Sometimes there’s an instrument rotation side of this too – in situations where we might want to stay in European equities but rotate from one manager to another.
- This aspect really differentiates us from our peers. We have three members of the team focused on this area, including James de Bunsen. They run some funds which are 100% invested in alternatives but for our Core funds and more traditional multi asset funds, they will have an exposure to alternatives which will be managed by our three alternatives experts. They’ll draw from a wide range of diversifying assets such as infrastructure, renewables, private equity, solar, hedge funds, commodities, commercial property etc.
For each fund there is input from each of these three teams. It ensures that the ideas are not only well researched but that a consensus approach brings much greater depth and strength to our management process.
IFAM: What’s your investment process for managing the funds and determining your asset allocation strategy? What do you invest in and why?
JH: We’re genuinely top down when it comes to our investment process. This is in as far as we’re trying to understand the drivers in the market and where we are in the economic cycle at any particular moment. Our decisions will all depend on the environment. To be honest, now is probably not the best example to use as things are so focused around political noise rather than traditional market fundamentals, but there are prevailing investment styles which tend to outperform depending on where you are the cycle. So in a recovery phase for example, you’d want to be more cyclically-orientated, while in a slow-down phase more defensive/quality styles of underlying investment should prevail. It’s a matter of identifying where we are in the cycle and then implementing it through the asset allocation strategy and then through instrument selection etc.
As we discussed earlier, we invest directly as well as into funds – which gives us another dimension. If you look at the funds we run together as a team, we cover all asset classes, all regions and all types of instruments too. If we take fixed interest as an example here, we cover the full range from: Government bonds, index-linked bonds, investment grade, high yield, emerging market debt, structured credit and even subsets within that such as duration variation. It gives us huge scope to position the funds appropriately in line with market conditions.
IFAM: How do you maximise the opportunities for returns whilst minimising the overall risks and volatility?
JH: When it comes to managing risk, we would argue that portfolio construction is the first line of defence. It is one of the great strengths of having a multi asset approach that, as managers, we can access such great diversification. It’s often said that “diversification is the only free lunch in finance” and this is a principle we certainly utilise. By being properly diversified, we can help clients manage and deal with periods of volatility and help them to stay invested.
The second element is the more dynamic side of asset allocation, which is managing the exposure to the fund in the light of changes in the macro-economic environment and market conditions. To do that we have a lot of different frameworks that we use to guide our shorter term decision making. We will look at factors like macro momentum, how growth and inflation are evolving, we’ll look at government policy – both monetary and fiscal and now of course we have look at trade policy as well, with particular emphasis on the China-US negotiations.
We’ll also look at investor sentiment and positioning as well as things like politics. This has become a very important consideration of late, most obviously with Brexit but also on a number of other important fronts around the world.
Thirdly, instrument selection has a big part to play here. Asset allocation is a major part of managing risk and helping clients to optimise the risk/return trade-offs but instrument selection enhances that as well by allowing for broader opportunities and diversification.
CHART 1 – S&P 500 cyclically adjusted P/E vs 10 year forward returns
Source: Bloomberg, as at May 2019
Data starts in 1969
Past performance is not a guide to future performance
PE= price to earnings
It would be good to lift the lid on this area a little bit more. In chart 1, we can see how expensive the world is at the minute, and this gives us a very important context for the benefits of diversification. The chart shows the P/E ratio on the Standard and Poor’s 500 index dating right back to 1969 and ranks it in percentile terms relative to its own history. So today, the S&P P/E is about 90th percentile relative to its own history over the period since 1969. That’s quite expensive. If we then consider the US Treasury ten year yield, relative to its own history, over the same time period it’s about 80th percentile today in terms of yield relative to its long-term history.
This makes us ask the question when were equities this expensive before? The answer is back in the days of the tech bubble in 1999/2000, which is when we were hitting the 100 percentile of expensiveness relative to its history. The problem today is that when we compare to that period, fixed interest is not going to offer the cushion it did then. In that period, whilst equities were really expensive bonds were fair value at 40th or 50th percentile. Because of quantitative easing (QE), these two primary asset classes have been bid up. Therefor when we’re talking about diversification, it is in the area of sub-asset classes where stock pickers can find opportunities away from the traditional indices. This is all about adding in genuine diversifiers.
We should also talk a bit more about correlation here as it’s so important. If we look across the portfolio we can see how equities are correlated to each other and the same within fixed interest. We therefore have to consider how diversification, portfolio construction and risk management interact meaning that we have to try and find areas to invest which are not all pointing in the same direction.
Chart 2: S&P 500 cyclically adjusted P/E vs 10-year forward returns
There’s a lot of history behind the 60/40 portfolio but we would argue that this has been technically challenged in the short term as a function of QE. The flip side on this is that valuation tells you absolutely nothing in short term, but it tells you everything you need to know in the long term as to what is your expected return. It can stay expensive for a long period of time so it’s not so simple as just going to cash or alternatives. As fund managers, we still need to have representation across the asset classes but to do so whilst being mindful of what the long term expected returns are given our starting valuations [see chart 2 above].
IFAM: Where do you currently see the best growth opportunities as well as challenges to performance?
JH: We can still see good opportunities to make money for our investors despite all the uncertainty. Perhaps we should consider the bigger picture first. We’re in the late stages of a bull market for all assets and late in the period of economic expansion. We think it’s appropriate to expect fairly modest returns from here across most asset classes and also to expect more of the recurrence of the sort of volatility we’ve seen over the last 18 months or so.
That being said, we still think it’s still too early just to shift into a low risk strategy such as holding larger exposure to cash/government bonds. We don’t believe that we’re heading into recession as yet and added to that these defensive assets are simply not priced attractively.
Equally, we think that it’s too late in the cycle to be heavily exposed to the riskier ends of the market. For example, we see these areas as being more vulnerable as growth begins to slow. As and when this happens, you begin to see some of the structural weaknesses in some sectors being exposed. Our core strategy from here is to focus on what we’d call mid-risk assets – such as corporate bonds. Here we’re looking across the range at investment grade and high yield bonds, emerging market debt, the quality end of the equity spectrum plus a wide range of alternatives too – such as infrastructure and renewables and other diversifiers that have low correlations to traditional assets.
Overall, our portfolios are built around the expectation that we’re moving into an era of sustained low growth and low inflation and an environment, in which interest rates will at levels that seem unusually low compared to recent decades
Of course, volatility can at times be a source of discomfort however it can also be an opportunity to rotate some assets and to add some value from a more active asset allocation style. We’re always alert to such opportunities.
IFAM: How do you measure success? Is it just about total return and performance?
JH: We think that there’s more to success these days than just about the overall investment performance. It’s a competitive space, and yes of course, performance matters but risk matters too. Performance is still front and centre but increasingly it’s broader than this. It’s more about what solution we can provide and whether we can tailor it to the way the adviser’s practice works. As an example a number of the solutions which we manage for advisers have an income requirement. Can we therefore look to continue to deliver a sustainable and natural income from the portfolio without eroding capital? This is a really attractive approach in a low return, late-cycle world with increased volatility as we benefit from the more defensive characteristics coming out of the more solid income-generating stocks.
Another important area to consider is whether the client holds particular investment beliefs around environmental, social and governance (ESG) factors. If so, to what degree can we give that client confidence in how we integrate ESG into our considerations when managing the portfolios? We challenge external managers very heavily when we meet them, on what ESG means to them and how it affects them. This reflects on how it goes through our ESG screening process. Of course, it’s not necessarily a key objective for every client but risk management is. So for every client we use ESG screening primarily as an additional risk tool, away from non-traditional financial metrics. Are we therefore getting better information on potential risks – reputational or otherwise – in a manager’s portfolio, and how do we challenge on that and engage with it. It’s all about trying to work in partnership with advisers and how they structure their businesses. Obviously risk and return is paramount but we’re going beyond that and aiming to provide a more holistic solution.
IFAM: Why should Janus Henderson be on the radar for advisers’ looking for appropriate multi-asset strategies for their clients?
JH: We have a well-resourced team with a broad range of skills, a rigorous approach to managing money and a strong track record. We’re genuinely top down in our approach. We generate primary, in-depth research and work from it. We take much pride and effort to determine where we are in the cycle and then consider the investment opportunities which this affords us. We’re in late cycle slowdown now and so that period of high returns fuelled by QE has gone. Partly as QE has gone and because we’re faced with so much political uncertainty, we believe that with lower expected returns and increased likelihood of volatility, this is the time for active management to outperform.
Chart 3 – Active managers add value when market returns are lower
If we look at chart 3, interestingly this shows us the market environments when active and passive approaches respectively outperform. It shows that active managers’ performance will lag during periods of elevated equity market returns for many reasons: they hold more cash, they don’t tend to chase the high momentum stocks.. Conversely, the chart shows us that in weak markets, active management – and that’s just the average active manager – outperforms. We think that we’re in the middle area which has a slight positive tilt towards active. If on top of that we can bring in our manager research background of identifying styles and those characteristics which we think are appropriate, then it gives us a sound basis for the portfolios. As an example, in our funds which have core income strategies, we’re looking for quality management like that behind the Investec UK Equity Income fund – who are looking at the subset between dividend yield – a value metric – but also a subset with quality. They’re focused on seeking out those more dependable, cash generative businesses which are also returning cash to shareholders.
At Janus Henderson, our team manages a range of funds in the multi asset space, all with a variety of investment objectives. We launched our Core Multi Asset Income range five years ago, strategies which are aligned to the Dynamic Planner risk bands of 3-6. The yield on these funds varies too as a function of the equity allocation. Everything on the desk however is run with the same investment ideology –a top down approach – but with differences by objective which accounts for the variance in the instrument selection, for example, in the more cost sensitive funds aimed at directly at consumers there’s even greater use of low-cost passive and smart beta.
We said it earlier, but it’s all about that free lunch principal. The only free lunch you get – especially at this point in the cycle – is an increasing focus on being genuinely diversified, on bringing in alternatives and those assets with a lower correlation. It’s also about having the resources to identify them and having the breadth in mandates which we have, in order that we can implement those ideas effectively for our investors.
Even though we say it ourselves, we have got a great team here. Together we have a strong track record but more than that our team has been managing money since before the financial crisis. In that respect, it’s a crisis-tested team – which we believe is important experience. It’s a useful environment in which to evaluate the team and how well we are performing. We’re well-resourced, so clients can access strategies which have the full team of eleven of us working on it in one way or another, bringing a broad range of skills to the way we manage clients’ money.
But it’s not just about delivering off-the-peg solutions. We make a big effort to listen to advisers in order to understand their needs and to develop products and strategies to suit those requirements. An example of this was the launch five years ago of our Core Income funds. This all came about because advisers told us that’s what they wanted – a robust and diversified approach to investment with volatility management, with dependable natural income but all at lower cost. We built it to meet those demands and it’s a strategy that equally relevant today.
Looking ahead, if there’s one particular strategic change in the air for us, it’s increasingly about moving from products and towards building more customised solutions for advisers and their clients. We’ve got all the skill sets and resources here to deliver, so if our existing product range isn’t entirely suitable for you, we can work with you to build a more customised solution. It’s an exciting way to work and this is the way which we see our business going over the next decade. We’re looking forward to the challenge.
About Dean Cheeseman
Dean is a Fund Manager on the UK-based Multi-Asset Team at Janus Henderson Investors. He has co-managed the International Opportunities strategy since 2019. Prior to joining the firm in 2017, he was a portfolio manager and member of the asset allocation committee from 2011 at Mercer, where he contributed tactical asset allocation ideas for all multi-asset and equity strategies. Before that, Dean was with F&C Asset Management from 2007 to 2010, finishing his tenure as head of fund of funds. Earlier, he was head of developed markets with Forsyth Partners from 2001 and head of collective investments at Morgan Stanley’s Quilter from 1998. He began his career as an investment analyst in 1995 with Chartwell House Asset Management.
Dean holds a BA degree (Hons) in financial services from Nottingham Trent University. He has 24 years of financial industry experience.
About Paul O’Connor
Paul O’Connor is Head of the UK-based Multi-Asset Team focused on asset allocation at Janus Henderson Investors. He is also a Portfolio Manager on the International Opportunities strategy and numerous multi-asset portfolios. Prior to joining Henderson in 2013, Paul was head of asset allocation (EMEA) at Mercer.
Paul holds a first class BA degree (Hons) in economics and an MSc in economics from the London School of Economics. He has 24 years of financial industry experience.