More than £22 billion is currently languishing in consistently underperforming multi-asset funds according to a recent report from Asset Intelligence, with the consultant calling for a ‘great reset’ in this sector.
While agreeing with many of the points made in this research, we believe the underlying issue is actually more fundamental: seeing multi-asset performance as a relative game, rather than focusing on ultimate client outcomes, can often take investors down the wrong path.
To focus on those numbers first, of £155 billion invested across the three main IA Mixed Investment sectors (the 0-35%, 20-60% and 40-85% Shares categories) at the end of 2020, more than 14% was in funds that have been consistently third or fourth quartile over three, five and 10 years. Meanwhile, funds in the largest Mixed Investment 40-85% Shares sector have captured around 83% of the downside of the MSCI ACWI (global equity) Index to the end of 2020 but just half (51.5%) of the upside.
The report identifies three main issues with many multi-asset funds and proposes radical change within these as part of a reset. The first calls for diversification that ‘actually delivers’, moving away from judging funds based on their level of equity risk (and categorising by percentage invested in shares) and towards a system that appropriately identifies growth assets and those providing more defensive ballast. This question of risk touches on where we believe a wider reframing of multi-asset is required so we will come to that later, but as for diversification, this remains central to our process as a key, but often misunderstood, element of successful multi-asset investing.
Asset allocators often talk about the freedom to zero weight areas as a sign of their active approach but we feel this fundamentally misses the point. Zero weighting is not diversification and while it might be uncomfortable to hold a falling asset, something else is likely to be rising at the same time and it is the overall blend that helps produce a smoother performance ride over the long term. This is an integral part of our winning by not losing investment philosophy.
This leads to the next criticism, that many multi-asset funds suffer from ‘extreme home bias’ in terms of unjustifiably high exposure to UK equities, which can cause sub-optimal performance. The average multi-asset fund has more than 20% invested in the UK, for example, versus less than 5% in the MSCI All World Index. In contrast, our WSS Growth 4 Portfolio (in our 1 to 10 target risk range) had 12.5% in UK equities at the end of March (and another 7.5% in UK smaller companies) but these weightings are determined by strategic asset allocation (based on contribution to risk) and tactical asset allocation (taking advantage of valuation opportunities where we find them) rather than simply versus an index position.
Finally, the report contends that fund selection in the multi-asset world has often disappointed when it comes to finding high-quality active managers that generate excess returns for clients. Encouragingly, it does not fall into the usual trap when critiquing multi-asset, suggesting everything can by fixed by a passive approach, and acknowledges active management will be more important going forward following the largely positive last decade in equity markets. To quote, finding high-quality active management relies ‘on each component playing its part and pulling its weight, and is based on proper research built up over decades of watching and learning’; as might be expected, we would clearly agree there.
Despite all the efforts of the passive lobby in recent years, our view has always been that there are opportunities for quality active managers to add value. We suggest the data show that for patient investors like us, there is enough dispersion in returns to identify manager skill and select those who can outperform over the long term.
If we look at 10-year annualised returns from UK equity funds in the chart above, for example, the FTSE All-Share has produced average annual performance of 5.6% over the last decade. While there are plenty of active funds below that level, there are far more above it. What we can also say with certainty is that there are no broad passive funds above that line (of the two, one is a FTSE 250 tracker and the other a specialist sustainable offering).
To find these long-term active winners, we look for various characteristics, and a core one is that while we believe consistency of performance is ultimately impossible over every timeframe, consistency of process is a must. We tend to favour managers who mirror our own patient approach, showing clarity and consistency of process plus courage and conviction in executing it. We need to be confident that if we select a fund to fulfil a particular role, the manager will stick to his or her process whatever the market backdrop.
Overall, the figures make it hard to argue against the conclusion that too many multi-asset funds have failed over the long term but the report also includes comments that move towards our view of the wider reframing of the sector. These include that not all multi-asset funds can be compared on a like-for-like basis and more creative questions are needed, such as how to shift to allocations which focus on outcomes and how to gain diversified equity exposure via more risk-managed approaches.
For us, these are key considerations for long-term wealth generation. While performance is usually and understandably regarded as a relative game for any investment, including multi-asset, we believe ultimate success can only be measured in meeting client outcomes – and for that, target risk is the optimum approach. Our Multi-Asset portfolios and funds are designed to meet client goals in terms of suitability, targeting risk over the long term rather than outperforming peers or markets over shorter-term periods.
Rather than review performance against peers, we compare each one against the rest of the specific Liontrust risk range to ensure we are achieving two objectives over the short, medium and long term. The first is to target the outcome expected in terms of risk, measured by volatility, enabling investors to select the most appropriate portfolio for their needs; the second is to maximise the return for each portfolio within those risk parameters.
To state the obvious, many multi-asset funds are still target return, meaning decisions are, first and foremost, based on potential contribution to performance. This means, at times, some may take a more aggressive approach, increasing exposure to momentum equities, for example, to try to ride a rise in stock markets.
This fundamental difference means it is vital to understand the approach taken by each multi-asset manager; for our part, we maintain a consistent long-term process built around strategic asset allocation (SAA) and diversification, and while we often tilt towards cheaper assets, large-scale shifts into or out of markets to capture momentum rallies are not possible.
SAA is the engine for our target risk approach, with the team collating and analysing historical returns and volatilities of a range of asset classes to determine the optimum allocation to provide various levels of volatility. As well as historical returns and volatilities, the team also studies the correlations of the asset classes with each other and the pathway of future interest rates to determine the SAA. This provides the default asset allocation should the managers have no views about the relative attractiveness of different asset classes and gives natural diversification based on risk rather than just benchmark weighting.
On top of this, we apply tactical asset allocation (TAA) to increase exposure to an asset class when it looks cheap and reduce when expensive; our focus is on valuations rather than market timing and we believe it is important to supplement the long-term benefits of SAA with flexibility to take advantage of shorter-term opportunities. Finally comes fund selection, where, as stated, we believe it is possible to differentiate genuine skill from luck and use our SPURS system to identify the few managers that meet our criteria:
- Stamina – We favour patient, long-term investors from a similar mould to us and prize managers who can point to endurance and experience
- Process – A robust and repeatable investment process is a must for our chosen managers: while consistency of performance is impossible 100% of the time, consistency of process is a must
- Understanding – Among the softer attributes we look for are knowledge, insight and wisdom
- Resoluteness – Along with courage and conviction, determination and decisiveness
- Stimulus – Another factor to consider is a manager’s environment: what are the incentives and motivations for them to perform and what is driving them
We would suggest plenty of other changes in a great reset of multi-asset – focusing on patient investing for example rather than trying to time markets – but ultimately this and the three points suggested in the report are components of a more fundamental shift. The fact huge amounts of money is sitting in funds that are nominally ‘underperforming’ is a clear cause for concern; but until we move away from a one-size-fits-all, ‘relative return in peer group’ mindset towards meeting client outcomes and getting the correct balance between risk and return, we would argue much of the sector remains unfit for purpose.
