Christopher Bishun: How has Vanguard Lifestrategy performed compared to active alternatives?

For investors of the last decade, risk is no longer an abstract concept, and has become more tangible. Saving pots have seen wild fluctuations in value over the quarter, leading to investors reassessing their market composure, and questioning what kind of exposure they want to have to risk assets.

Correlations of asset classes have typically converged during sell offs, begging the question of how multi-asset funds have performed, and whether active management has been able to mitigate losses compared to passive strategies.

Multi-asset funds are widely held vehicles for meeting investment objectives, whilst providing access to a diverse range of revenue streams. The Vanguard LifeSstrategy funds, for example, offer passive exposure to markets across five different blends of equities and bonds, targeting varying levels of risk and return, whilst maintaining static strategic asset allocations.

In reviewing the IA mixed investments categories, the 0-35% equity allocation provided the strongest return in the first quarter at -8.0% versus the FTSE 100 down 24.8%, albeit not comparing apples with apples. A portfolio’s equity allocation drives the majority of its risk contribution, and particularly when focused on the short term, regional allocations can contribute significantly to that risk element. Lifestrategy 20% equity in comparison lost only 2.6% over the same period, whilst maintaining a similar level of volatility to the peer group.

This outperformance versus the peer group can be seen across other Vanguard Lifestrategy funds as seen in the chart below. From an investor viewpoint, a quarter is a very short time frame to meaningfully assess a strategy’s performance versus its stated objective, and a three or five year period provides a stronger indication. The outperformance of the Lifestrategy funds versus the peer group is even more stark, whilst providing positive risk adjusted returns as measured by the Sortino ratio.

Passive strategies have performed well in a market driven by quantitative easing, where all ships rise with the tide, however there are some other notable attributes to the Lifestrategy funds that have supported performance.

Investing in the 60% equity fund will provide exposure to 17 underlying funds containing a total of 19,822 equity and fixed income holdings, providing diversification both across and within asset classes.

Given the underlying indices are market cap weighted, there is an inherent overweighting to large-cap stocks, and momentum plays, such as the technology sector.

Government bonds have seen strong performance during the sell off, with the asset class comprising six of the top 12 best-performing Investment Association sectors between February 20 and March 23. Historical government bond correlation to risky assets during a crisis is -0.35%, providing a source of portfolio convexity. Many multi asset solutions have remained short duration to limit fluctuations in interest rate expectations, however exposure to different bond durations across the curve has benefitted the LifeStrategy range to ride out the recent market turmoil, relative to peer group averages. This has been somewhat counterintuitive to active managers who see the low yields and capacity for large fluctuations at the long end of the curve an area to avoid. The number of Vanguard bond building blocks is much narrower than some of its passive competitors, showing that fewer funds within the composition can be beneficial.

Source: FE Fundinfo; figures to end of March 2020 

An important factor is the regular rebalancing, which removes the emotional element of investing, avoids tactical trades and doesn’t attempt to time markets. This ‘hands off approach’ means that by design, there is no outperformance versus the benchmark index. This is in comparison to the Barclays Wealth Global Markets passive range or a fettered fund of funds (fund of internal active funds) such as Schroders Dynamic Multi Asset which apply tactical positions. Again, the LifeStrategy range provides stronger returns suggesting that overtrading may not add significant value.

Overall costs also continue to be a noteworthy benefit for passive strategies, and remains a pressure point for the active community, where fees can have a substantial drag on performance.

It’s also important to be mindful of what exposures an investor won’t obtain through these funds. They exclude other asset classes such as infrastructure, absolute return, property and commodities, which can add certain characteristics depending on an investor’s objectives.

The Jupiter Merlin range, for example, lies at the opposite end of the spectrum to the Vanguard LifeStrategy funds in terms of composition, comprising an open market fund of active funds approach. They are run by a high-profile team who monitor markets and underlying funds. The Merlin Conservative, Income and Balanced funds all outperformed their respective peer groups, yet lag versus the LifeStrategy funds over both short and longer time periods (Balanced 3 months -11.87%, 3 years +1.81%), whilst the OCF stands at 1.56% for the Balanced fund versus 0.22% for the LifeStrategy 60% Equity fund.

There are many options within the multi asset space, which can be confusing, and can appear very similar, yet yield very different outcomes. Investors can review these options in light of the macroeconomic picture and expectations going forwards. Coordinated stimulus has been positive for passive strategies, whilst increased and continued volatility may provide opportunities for active managers to shine. In a world of ZIRP (zero interest rate policy) or even NIRP (negative interest rate policy), investors may also wish to explore complementary yield and capital enhancing strategies external to these multi asset solutions.

Christopher Bishun is a CFA and investment solutions director at Brooks Macdonald