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Make the most of the many uses of multi-asset

Multi-asset funds can diversify portfolios, generate income and mitigate downside
October 10, 2019

Equity markets have historically been the main driver of investment returns and raced ahead in recent years. But equity prices look worryingly steep, with, for example, the S&P 500 hitting another record high a few months ago. Stock markets also face various challenges, including trade tensions and recessionary indicators, so diversification is vital to keep portfolios on track over the longer term.

Traditionally, many investors followed a simple 60/40 per cent formula of equity to bond exposure, with the latter serving as a diversifier when stock markets fall. But the substantial rise in bond prices this year means that many fixed-income instruments look expensive and highly correlated to equities. As such, they could suffer just as much if markets take a tumble. So you should seriously consider taking a broader multi-asset approach in your portfolio, diversifying away from equities with bonds, but also property, commodities and in some cases more esoteric assets.

You may be able to do this by complementing your core holdings with other investments accessed via funds. Doing this can make sense – for example, it can help to keep a lid on costs and maintain a degree of portfolio simplicity. But if you are looking for exposure across various asset classes there are good reasons to consider including multi-asset funds.

However, multi-asset funds reduce the level of control you can exercise over your investments. Investors who get exposure to assets such as equities or bonds by investing in them directly or via single-asset funds can monitor their overall asset allocation more easily. But holding a multi-asset fund can make it less straightforward to judge your portfolio's overall asset allocation. You also need to be sure that such a fund has an asset allocation in line with your views and make sure that any changes within it don't skew your own overall portfolio's allocation too much. If a multi-asset fund moves heavily into bonds, for example, this would increase your overall portfolio exposure to this asset.

“In general I prefer to achieve [diversification] via exposure to each asset [separately],” says Justin Modray, director at Candid Financial Advice. “For example, using funds that invest in fixed interest, commercial property, infrastructure and alternatives, respectively. This allows a bespoke approach and makes tweaking the exposure to each asset straightforward. It also avoids the stock market exposure within the multi-asset fund potentially overlapping with what you hold elsewhere in your portfolio.”

Investors risk replicating their existing exposures if they add multi-asset funds to their portfolios because these funds may hold equities, funds or other assets that are already in their portfolios. This can be a particular problem with equities because these often form large parts of both private investors' portfolios and many multi-asset funds.

“It’s difficult mixing and matching different approaches when investing as there is always the danger of crossover and doubling up on a particular area,” adds Ben Yearsley, director at Shore Financial Planning. “For example, if you invest in sector funds focused on areas such as technology your normal mainstream funds might also have tech exposure."

He says that the same risk applies if you hold multi-asset funds alongside single-asset funds.

If you use multi-asset funds you should monitor their underlying holdings and broader asset allocation to see whether there is any crossover with your portfolio. But monitoring every single holding may prove difficult because fund factsheets often only disclose the 10 largest investments.

Multi-asset funds can also have high charges because they invest in other funds, invest in assets that require significant due diligence and generate more work because they invest in a wide range of assets. This could make your portfolio more expensive to run than if you only invested directly in assets or in single-asset funds.

As with other funds, you also need to hunt far and wide to find multi-asset funds that offer genuine outperformance. Research company Finalytiq's latest annual report on multi-asset fund performance covered 391 funds with assets worth more than £125bn, offered by 89 different providers. However, most of these underperformed simpler portfolios entirely invested in equity and bond trackers where weightings were aligned with the active funds’ own rough allocations. Only 10 fund providers’ ranges delivered better risk-adjusted returns than the simpler portfolios over a five-year period.

Costs also varied significantly, as table 1 shows. The highest ongoing charge was 2.91 per cent and the lowest was 0.16 per cent. This significant gap is partly because of the disparate approaches these funds take. Multi-asset funds that invest in other funds can accrue significant fees because they hold several active managers, but others only invest in tracker funds keeping their charges lower.

 

1.Multi-asset fund ongoing charges (%)
Highest2.91
Upper quartile1.29
Median0.95
Lower quartile0.63
Lowest0.16

Source: Finalytiq

 

Multiple reasons to favour multi-asset

But don't write off multi-asset funds – even if you are accustomed to assessing holdings yourself. These funds can serve many functions, from forming the backbone of a portfolio to filling a gap.

Although multi-asset funds can make it more difficult to monitor your portfolio they can also make life simpler if they are used as core holdings. This could be a useful approach for many investors, including those starting out and taking a more straightforward approach while learning more about markets.

“Multi-asset funds can make sense in smaller portfolios where manually combining asset types might be impractical or overkill,” says Mr Modray. “The advantage is simplicity, the disadvantage is lacking the same control versus selecting funds for each asset yourself. You might also end up paying higher annual fees.”

Others may find using multi-asset easier because it enables them to use fewer funds so have fewer portfolio holdings to monitor. Or if you used to run a portfolio of direct holdings or single-asset funds but now feel less enthusiastic doing so, maybe because of time constraints or just because you want to spend less time managing your investments, you may wish to largely outsource the management of your assets to a dedicated professional.

Just one multi-asset fund can be a sufficient core of a portfolio to which you can add more specialist funds as “satellites”. If this approach reduces the number of funds you use it could also reduce the potential amount of fees you pay – even if the multi-asset fund you use is more expensive than some of its peers.

A less common but equally viable approach is to build the majority of the portfolio yourself, but include some small exposures to multi-asset funds. For example, they can offer exposure to assets that might be hard to access directly or via single-asset funds such as hedge funds, private equity or overseas property. Or if you are particularly keen on an asset but are not satisfied with what is on offer from funds focused on it you could consider accessing it via multi-asset funds.

Some multi-asset funds can also help to preserve capital. Equity prices look exposed to a turn in sentiment, but so do traditional diversifiers such as bonds. And when safe assets increasingly look expensive or difficult to hold in a portfolio due to issues such as illiquidity, a flexible fund with the ability to move in and out of different areas may be able to strike a good balance.

“You could use multi-asset funds that try to mitigate downside while adding in spicier, more specialist holdings to complement them," says Mr Yearsley. "This could be a core and satellite approach, but watch out for any double exposure to areas or sectors."

Multi-asset funds can also be a good way to generate income. A low interest rate environment and the strong performance of safe-haven assets such as bonds mean that good yields remain difficult to find. Areas that do still pay a good yield often come with notable risks, for example emerging market debt funds are vulnerable to defaults and political shocks, while UK equities face a number of problems. Multi-asset funds are worth considering because they can diversify across a wide range of assets when looking for yield, and some can also access markets that are not widely available but offer attractive yields.

 

Picking the right multi-asset fund

To determine which multi-asset funds may suit you best you should consider what your desired investment outcomes are and what views you have on markets.

There are six Investment Association (IA) sectors and one Association of Investment Companies (AIC) sector that include many multi-asset funds. These sectors include 830 funds in total, although not all of them take a multi-asset approach. 

The IA Mixed Investment sectors break out funds according to the minimum and maximum amount they can allocate to equities, meaning you can roughly assess where you might find a fund that fits your asset allocation views. But the IA and AIC Flexible Investment sectors allow funds free rein with asset allocation, so the approaches of funds in these sectors can vary significantly.

The IA Volatility Managed sector includes funds that aim to take assigned levels of risk, with ranges tending to cover much of the risk scale. If you have a clear idea of your risk tolerance, a fund with a risk target could be a good core for your portfolio.

IA Targeted Absolute Return is a much more complicated sector to assess because it contains funds with highly disparate approaches. Some absolute return funds focus on generating an absolute positive return and mitigating downside over a set period, or beating a target amount such as inflation. These attempt to invest in a steady, defensive manner, but other funds in the sector have been extremely volatile over time.

So while these sectors can be a useful starting point it is very important that you gather as much information as possible about the funds you are thinking of investing in from sources including their own literature, fund buy lists or wealth management professionals such as independent financial advisers.

Rory McPherson, head of investment strategy at Psigma, explains: “The attraction of holding a multi-asset fund is obvious: most of them aim for equity-like returns with commensurately less risk. But finding the right one is less easy and there are some important checkpoints a would-be investor would want to establish. It’s important to establish what level of equity risk a fund has and what its characteristics are like in down markets. Many funds publish ranges for their asset class weightings, but these tend to be broad so you need to get a handle on what their actual characteristics tend to be.”

 

Multi-asset funds to consider

Multi-asset funds may just invest in equities and bonds, or include more unusual assets. They also differ in terms of how much they invest directly, and how much they use active or passive funds. This can affect costs and performance.

The Vanguard LifeStrategy funds have performed well, and invest in equity and bond tracker funds from the same provider, which enables them to have extremely low charges. These funds' maximum permitted exposure to equities varies from 20 to 100 per cent. These could form a good portfolio core but do not invest in anything other than bonds and equities. Finalytiq also says that they are “somewhat overweight in exposure to the UK, have a large-cap equity bias and are invested in fixed-income securities with medium credit quality and high interest rate sensitivity”. 

For example, Vanguard LifeStrategy 80% Equity (GB00B4PQW151) had 18.8 per cent of its assets in UK equities at the end of August.

Other passive-based ranges such as Architas MA Passive and Legal & General Investment Management's Multi Index funds could also be used as a base for a portfolio. These differ in terms of cost, asset allocation and what they tend to invest in.

If you want a more active core in your portfolio, Rathbone's multi-asset range managed by David Coombs tends to invest directly in areas such as equities to keep a lid on costs and closely monitor risk, and in investment trusts for more esoteric asset exposure. The funds adhere to set targets on performance and risk. For example, Rathbone Multi Asset Strategic Growth (GB00B86QF242) looks to return between 3 and 5 per cent more than consumer price index (CPI) inflation over a minimum five-year period, with no more than two-thirds of the volatility of MSCI World index.

If you are looking to mitigate downside, Liontrust Sustainable Future Defensive Managed (GB00BMN90635) has done well in recent years, strongly outperforming the IA Mixed Investment 20-60% Shares sector average return over one, three and five years to the end of September. The fund looks for socially beneficial investments in line with themes chosen by its management team and tends to have 45 per cent of assets in global equities, and 55 per cent in bonds and cash.

If you are after income, Seneca Diversified Income (GB00B7JTF560) is among the top performers in the IA Mixed Investment 20-60% sector over one, three and five years, and had a historic net yield of 4.9 per cent at the end of August. The fund’s managers invest directly in UK equities but access other areas, such as unlisted equities and infrastructure, via funds.

Premier Multi-Asset Distribution (GB00B40RNW10) has a yield of 4.5 per cent and a strong performance record. It invests in mainstream assets, but also delves into niche areas such as P2P lending and infrastructure via specialist funds.

For exposure to more esoteric assets, Mr Yearsley suggests Architas Diversified Real Assets (GB00BRKD9X30), which invests in assets including gold, renewable energy and asset leasing. The fund has a yield of more than 3 per cent and could also help to diversify portfolios focused on mainstream assets.

 

Performance

Fund/benchmark1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)10-year cumulative total return (%)Ongoing charge (%)
Vanguard LifeStrategy 80% Equity6.8529.6162.70 0.22
Rathbone Multi Asset Strategic Growth5.5421.6442.3097.620.66
Liontrust Sustainable Future Defensive Managed8.0525.3348.99 0.93
Seneca Diversified Income7.1721.6738.4185.911.18
Premier Multi-Asset Distribution3.8816.0233.93114.341.3
Architas Diversified Real Assets4.308.3821.53 1.14
UK Consumer Price Index inflation + 3%4.4916.8724.9866.84 
UK Consumer Price Index inflation + 5%6.3523.6037.36101.89 
IA Mixed Investment 20-60% Shares sector average60% Shares4.0113.2827.4167.82 
IA Mixed Investment 40-85% Shares sector average4.2019.7539.0094.71 
IA Specialist sector average7.5819.5336.5564.79 
IA Volatility Managed sector average4.7616.7235.2285.84 

Source: FE Analytics, as of 31 September