Multi-asset funds, as their name suggests, contain investments across several different asset classes – equities, bonds, cash, real estate and possibly other ‘alternative’ asset classes – with the fund manager deciding on the proportion and type of investment going into each. At one end of the spectrum, those multi-asset funds investing mainly in equities, in particular with a significant Emerging Market component, would be expected to deliver higher returns over the medium to long term but also to come with greater volatility (risk). At the other end of the spectrum, multi-asset funds containing mostly bonds and cash should be less risky but will probably give less return in the long run. The latter would likely be more suitable for investors in or close to retirement and/or those uncomfortable taking risk. While the former will probably be used for clients with a long time to retirement and able to tolerate higher volatility in order to achieve greater returns.
At Defaqto we believe the multi-asset universe can be divided along four different lines:
- Multi-manager verses direct investing
- Risk-targeted or return-focused funds
- Active or passive investing or a combination of the two
- Using just ‘traditional’ asset classes or using traditional and alternative asset classes
1. Multi-manager verses direct investing
Some managers of multi-asset funds will invest in other funds specialising in the relevant asset class – known as multi-manager – while others invest directly in securities themselves. The rationale for multi-manager investing is that no one manager can be the best across every single asset class and instead, one should seek out a specialist manager for each different area. The disadvantage of this approach is that by employing other managers, an extra layer of fees will be introduced, making multi-managers more expensive on average.
Multi-manager funds can be either fettered or unfettered. In the case of fettered, the multi-manager can only select funds from elsewhere within their organisation. The advantages of this approach are, firstly, costs will usually be lower, helping to mitigate the above disadvantage of higher fees, and secondly the multi-manager will have constant and more detailed access to the underlying managers – often they will be sitting just a few desks away from each other! Also, fewer managers to concentrate on allows for greater focus. With the unfettered approach, the manager can select funds they believe to be the best from any organisation. The big advantage here is that the opportunity set is much larger, not only in terms of funds but also investment styles and strategies, with the result that the manager should be able to achieve greater diversification and therefore lower volatility for the same level of return (or greater return for the same level of volatility). Defaqto, together with much of the fund management industry generally, do not believe that one approach is better than the other. In fact, we’ve seen many recently launched ranges offering a combination of the two – fettered funds for some asset classes – where the organisation believes they have strong expertise in-house – and unfettered for others.
2. Risk-targeted or return-focused funds
Some multi-asset funds will directly target the volatility of the fund, usually aiming to keep it within pre-defined bands, with return being the secondary consideration. Others, meanwhile, will aim to achieve a certain amount of return, although they will usually still be bound by risk in some way e.g. through the Investment Association (IA) sector they sit in. In the case of those targeting risk, this will be achieved mainly through varying the asset allocation; for example, if the fund’s risk level becomes too high then the equity proportion will be decreased and the amount in bonds and cash increased. Risk can also be varied by changing the weights of the underlying funds, where applicable – putting more in ‘core’ funds (those that are highly diversified and following mainstream indices) and less in ‘satellite’ funds (funds with less holdings, higher performance targets and possibly more specialist in nature) in order to reduce risk.
3. Active or passive investing or a combination of the two
The investment method of multi-asset funds may be active, passive or a combination of the two. With active management, there is the chance to outperform the respective index, but also the risk of underperforming it. Passive funds, meanwhile, simply track the index and will normally be much less expensive. It is often the case that the multi-asset manager will use active investments for the asset classes where the market is believed to be less efficient and researched, such as Emerging Market equities and high yield bonds, but passive investments where the market is seen as very efficient e.g. US equities and sovereign bonds. In terms of overall asset allocation, however, the management method will be active i.e. the multi-asset manager must still make an ‘active’ decision when allocating between the different asset classes.
4. Using just ‘traditional’ asset classes or using traditional and alternative asset classes
Multi-asset funds may invest in just ‘traditional’ asset classes (equities, bonds and cash) or traditional and ‘alternative’ assets (such as private equity, hedge funds, commodities and infrastructure). The latter type offer greater potential for higher returns and diversification; however, they can also be more risky and expensive and less transparent. In conclusion, multi-asset funds take the asset-allocation and fund/security selection decisions from the adviser, leaving the latter with the task of selecting the ‘right’ fund for the client. However, there are many different types of multi-asset fund on the market. As seen above, the various ways they can be constructed have different advantages and disadvantages and the final choice will often depend on the adviser’s and client’s preferences, investment beliefs and tolerance of risk.
About Patrick Norwood
Patrick joined Defaqto in May 2013. His key responsibilities include producing, reviewing and developing Defaqto’s Diamond Ratings and Risk Mappings for funds, writing publications and commentary on key issues within the fund management sector and working on bespoke case studies and consultancy projects. Patrick also represents Defaqto at industry forums and events. Patrick has over 20 years’ experience in researching and selecting funds and fund managers, across multiple asset classes, and is a Chartered Financial Analyst.