There can be little doubt that when it comes to Multi-Asset funds, it’s not a case of one size fits all. In this article by Fraser Donaldson, Investment Consultant at Defaqto, Fraser lifts the lid on the asset allocation of different Multi-Asset funds and shares practical tips on some of things that advisers should be looking for when doing due diligence in this complex sector.
For as long as I can remember, data providers and investment associations have had a rather tricky tightrope to walk in terms of investment classification.
It is probably 20 years since I was on the Investment Association’s (IA) performance category committee, which monitored, updated and occasionally added to their sectors, based on where and in what assets the unit trusts and OEICs of their members were invested.
One of the things that stuck with me from that time, particularly as far as the IA was concerned, was that whatever classifications were used, they had to be both understandable to the client and sensible for the adviser.
Lifting the lid on asset allocation
So, while granularity can add accuracy, it can also add complexity and there is the danger of losing client understanding. Nowhere is this conundrum more exposed than in the Multi-Asset sectors, which are defined by limits to the exposure to equities, a reasonable proxy for the amount of risk taken by portfolio managers. Actually, I think the IA have got this about right, giving clients and advisers a sense that they are looking, broadly, in the right peer group.
Of course, certainly for advisers, this is where the work should start. Chart 1 shows the average asset exposure for each of the three IA mixed sectors, simplified into equity, cash and other.
Chart 1
| IA Mixed Investment 0-35% shares | IA Mixed Investment 20-60% shares | IA Mixed Investment 40-80% shares | |
| Equity average% | 23.3 | 40.8 | 63.0 |
| Cash average% | 6.7 | 4.6 | 3.1 |
| Other average% | 70 | 54.6 | 33.9 |
| Cash low% | 0 | 0 | 0 |
| Cash high% | 35 | 37 | 40 |
| Equity low% | 10 | 13 | 15 |
| Equity high% | 42 | 67 | 100 |
So, if we take a look at the average equity exposure to the funds in the three sectors they are pretty much as you would expect, roughly in the middle of the defined exposure parameters. However, when you look further down the table, it underlines the need for further due diligence from the adviser. The IA sector definitions also stipulate defined exposure to fixed income/cash, contained within ‘other’ in the table above, but let’s concentrate on equity exposure.
There are considerable spreads between the highest and lowest equity exposures in each of the three sectors, with as much as 85% in the 40 to 80% shares sector. This raises a number of questions that need to be answered before a possible fund selection for a client.
The need for questions – and answers
Assuming accurate data provision by the fund managers – and it would be wise to check this – the first and most obvious conclusion is that there are clearly a number of funds that are not sitting within the limits imposed on equity exposure. Of course, there may be tactical reasons for this in that a short-term opportunity has been pursued. None-the-less, questions need to be asked and the answer needs to be acceptable to both client and adviser.
Let’s say you are now comfortable with the outliers and just suppose that you are now close to selecting a fund that sits right in the middle of the peer group in terms of equity exposure – you still can’t take this for granted. For instance, in terms of risk and potential volatility there is a considerable difference between Emerging Market equities and, say, equities of a developed market such as North America, and that is before you start looking at small cap vs large cap.
What’s in a name?
So, let’s take a look at the numbers for this example shown in Chart 2:
Chart 2
| IA Mixed Investment 0-35% shares | IA Mixed Investment 20-60% shares | IA Mixed Investment 40-80% shares | |
| North American equity average % | 9.4 | 15.3 | 25.8 |
| Emerging Markets equity average % | 1.53 | 2.69 | 4.07 |
| North American equity high % | 17.7 | 44.2 | 73.2 |
| North American equity low % | 0 | 0 | 0 |
| Emerging Markets equity high % | 7.68 | 19.93 | 14.7 |
| Emerging Markets equity low % | 0 | 0 | 0 |
This raises more questions. The averages look sensible, but are those high and low percentages an indication of the portfolio managers’ approach to investment? Or could they be chasing a return after a period of poor performance?
For instance, I happen to know that the fund that has the ‘high’ in Emerging Markets is designed to do so and in fact the fund name indicates as much. That is fine, as long as it is obvious, but there are others where questions still need to be asked.
The bottom line is that funds that are selected should broadly have a risk profile that matches the clients’ attitude to risk. To ensure this, fund due diligence does need to be deeper than just reading the headline numbers. And, let’s not forget, I have focused on equities here and it is likely that similar uncertainties will manifest themselves in other asset classes.
Most importantly, we all need to remind ourselves from time to time that it is our job to deliver outcomes that the client expects and needs, and we should be aiming to do that by taking no more risk than the client is comfortable with. Shooting the lights out in terms of performance is great, but it also comes with associated risk and therefore increasing probability that outcomes may not turn out as required.
About Fraser Donaldson
Fraser Donaldson is an investment consultant at Defaqto – one of the UK’s most trusted sources of financial product and market intelligence. With 30 years’ experience, Fraser’s areas of expertise include discretionary management and Multi-Asset investing. Defaqtois a leading financial information, ratings and fintech business that supports financial institutions, intermediaries and consumers to make smarter financial decisions.
