The UK’s multi-billion pound multi-asset sector has “mislabelled” risky assets within portfolios, exposing investors to greater risks than they actually realise, according to Asset Intelligence.
The majority of multi-asset funds are placed in one of three sectors, all of which are defined by their exposure to equity markets (Mixed Investment 0-35%, 20-60% and 40-85%).
However, this overlooks the exposure to other risky assets, such as emerging market bonds, which are counted towards the fixed income exposure of multi-asset funds when they could cogently be considered in the same risk category as equities in many cases.
Looking at the correlation of different assets, emerging market bonds, and global bonds, have a closer correlation to global equities (defined as the MSCI ACWI) and other equity markets than they do to government bonds, for example (see chart below).
If two assets have an expected return correlation of 1.0, that means they are perfectly correlated, so if one gains 5%, the other gains 5%, and the same if they drop in value. A perfectly negative correlation (-1.0) implies that an asset’s gain is proportionally matched by the other asset’s loss, while a zero correlation indicates the two assets have no predictive relationship.
With a correlation of 0.77 and 0.79 respectively for local and hard currency emerging market debt, and 0.84 for global high yield bonds, allocating to these assets in the expectation that they will offer real diversification if equities sell off shows a major flaw within multi-asset funds.
Robert Love, head of research & principal at Asset Intelligence, said: “At the heart of this problem is a labelling issue.
“Assets such as High Yield and Emerging Market Debt are fixed income assets and therefore don’t count towards the equity allocation of funds, but evidence shows they correlate closely to equites, particularly in periods of market stress.
“By leaving them out of the fund’s “risk” category it means investors are left exposed to assets which will act more like equities but which they assume are giving them protection. This is a poor outcome for clients who won’t know what risks they are really exposed to.”
Part of the issue stems from the IA sector definitions, which only categorise funds by their exposure to equities, not other assets – however equity-like they may be.
“Many multi-asset funds include many different asset classes, but by mislabeling these assets, they have been making investments in the part of their portfolio considered to be defensive, only to find it is anything but.”
Asset Intelligence believes a better solution would see advisers and their clients offered truly diverse portfolios which provide commonsense exposure to assets according to how they actually behave.
This “attack and defence” combination would allow advisers to have some certainty that the proportion they allocate to defence actually defends the money invested in it, rather than merely mimicking (albeit to a slightly lower degree) the moves seen in the high-risk part of clients’ portfolios.
“It was a nice marketing idea to put a collection of assets into one fund and call it portfolio management, but the reality is that in many cases multi-asset funds offered to advisers and their clients don’t offer investors the risk profile they think they do,” Love said.
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