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Why the rules are less clearly defined for multi-asset funds today

21 October 2018

Multi-asset is evolving from straight forward cautious and balanced outlooks to outcome-orientated and targeted-return strategies. But as investors enter a new era of quantitative tightening, a focus on traditional, long-term metrics will be key to achieving success according to Prudential Portfolio Management Group’s (PPMG) Andy Brown.

The investment industry has been on a steep learning curve over the past decade, with regulatory change, political revolutions and monetary policy upheaval leading to unprecedented market economics.
It has changed multi-asset investing in particular – not always for the better argues Andy Brown, Investment Director at Prudential Portfolio Management Group (PPMG).
“An analysis of multi-asset funds over the last few years reveals there have been very few losses within the portfolios – if any at all. This sounds great. But multi-asset funds are not supposed to do this. It is not how or why they were built. A multi-asset fund should be able to hold up returns in good times, but balance off negative markets and provide an element of protection against risk when they fall. The fact that everything appears to be going up can lead to future expectations being unsatisfied.”

Unorthodox monetary policy and a lack of volatility since the global financial crisis has created a unique set of investment circumstances for multi-asset investors, according to Brown. Investors who two decades ago would have been content to buy gilts alongside a few stable equity holdings to receive a monthly income are today having to incorporate high-dividend paying, and at times risky, stocks in order to achieve a similar level of return. The wave of money being invested in so-called risk assets has resulted in values of most assets in the UK and US rising, and that means the yields on said assets have fallen.
Brown explains: “A multi-asset fund should help retail investors invest through market noise and risk-on/risk-off events to produce smooth, stable returns over long time periods. The problem is many investors think short term, and do not understand what market noise or volatility really means today. Especially as global central bank support has led many to view risk as effectively being ‘free’. This will no longer be the case as economies continue, or start, on a path of monetary tightening, however. The next three or four years will see investors experience a much rockier ride.”

Multi-asset evolution

For Brown the evolution of investment markets and fund strategies means rules are less clearly defined for some multi-asset funds. Many have moved on from single manager ‘cautious’ and ‘balanced’ strategies and there is an increased focus on outcome-orientated and targeted return vehicles. Some strategies in the multi-asset space now place less emphasis on long-term risk analysis and customer outcomes as they seek higher returns.

“Fund groups constantly search for mechanisms that can reduce risk but still provide higher or a targeted return set. In my mind that is alchemy. By reducing one element of risk you might well be increasing risk somewhere else in a portfolio.”
Brown insists fund groups must ensure the customer’s outlook is always at the forefront of investor strategies. In his experience, most investors don’t actually want to beat a benchmark; they want steady, consistent returns for the duration of time they are invested.

“What we actually need to be doing today is providing investors with a better idea as to the kind of outcome they can realistically achieve in the market today, and give them real information as to how much they could lose on a 10, 15, or 20 year basis.”

Long-term outlooks

PPMG’s multi-asset team does place long-term analysis and customer outcomes at the heart of its investment process. For PPMG, ‘long term’ means implementing an investment strategy for 10-15 years – and sometimes even longer. The team uses a range of tools to protect portfolios from extreme short-term impacts caused by market volatility and market noise through tactical allocation.

The group also uses ‘smoothing’, a well-established process that forms a core part of the wider group’s With Profit’s Fund investment strategy. Smoothing allows the investor to ride out shorter-term event-driven volatility and looks to provide greater consistency in terms of customer outcomes.

The process has allowed PPMG’s multi-asset portfolios to be more flexible in their weighting to risk assets and deliver more predictable returns by avoiding the ups and downs of volatile markets on a day-to-day basis.

For Brown, this process has never been more important for multi-asset investors given where the market is heading: “To me, volatility cannot be analysed over a three or four year period. On a one-to-three year time horizon a manager will often be driven by where markets are in the economic cycle and short-term politics, such as a changing government for example. But by doing that investors often end up paying a higher price for assets because they are constantly behind market trends and chasing them.”

PPMG believes that volatility must be considered over an entire economic cycle if investors are to successfully navigate market events and protect portfolios from drawdowns that can eat into returns.

“Some of the best investors talk about leaving the table before everybody else. In 1998, PPMG was criticised for moving out of the equity markets ahead of the dot com bubble. We probably did it 12-18 months too early. But, by 2003 we were streets ahead of the competition because we had assessed risk correctly ahead of the event and repositioned the portfolio. And again, if you look at the market today; if we are in the last upwards phase of a bull market today, we should be taking risk off the table. It should be decreasing from 90% to 85% and so on. We need to give up some return in order to protect our investor’s cash.”

Brown believe in most cases markets tend to do a lot of the heavy lifting, which means correct asset allocation of this type alongside risk assessment is key to successful returns.

“There will always be short-term periods where markets turn against you,” says Brown. “But if a manager can make the right calls on a long-term basis using a much wider spread of assets within a reasonable set of risk boundaries, it will eventually deliver against the type of outcome clients want. And to us, success looks like giving an investor what they expect to get.”

Lessons learned

Much of PPMG’s multi-asset expertise has been built on the same philosophy and values that serve Prudential’s With-Profits Fund – a portfolio that has produced positive results over the long term. Their approach to managing investments has meant that the group has maintained its annual bonus rates, and also delivered final bonuses for most customers in recent years.

“A With-Profits Fund is set up to provide a bonus rate and you have to manage the capital accordingly to do that. Once you have attached a bonus to an individual’s policy, the regulator will ask how much capital you have and take a view as to whether your capital can pay out that promise,” says Brown. “Management of the underlying fund is therefore with a much more liability-driven mind-set. And that overarching style of investing means we do try and focus on what the outcome should be at all times.”

The With-Profits Fund has also helped the group to access a range of ‘newer’ assets within its multi-asset ranges which are less correlated with traditional equities and bond assets, but often inaccessible to most asset managers.

For example, PPMG has been investing in diverse asset classes within the alternatives space, as well as African equities and Asian credit within its multi-asset vehicles since 2006.

Brown explains that if investors can identify these types of longer-term trends and buy them before market momentum pushes the price of those assets up, they are able to benefit from a significant upswing.

“We dipped our toe into African markets over a decade ago, and the small test investment has now resulted in a target allocation approaching £1.25 billion and we will probably be one of the largest UK based investors in African equities.”
Brown notes that while many investors found such asset classes inaccessible and too volatile to trade in, the wealth of experience of running the Prudential With-Profits fund, and a focus specifically on outcomes provides PPMG with confidence.
“As risk-free assets disappear, investors today have to sit back and really think about where to invest. That is where the expansion into less correlated assets is key. And it is the bigger funds, those with a wide enough structure like Prudential and PPMG’s that can access them.”

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