One problem with tackling anything to do with absolute return is it encompasses a wide range of strategies. However, the common link is that they all aim to achieve a return above a cash benchmark rather than a relative return above a particular equity or bond benchmark.
Same target / different approach
Structured either as hedge funds or multi-asset funds, they both have aim to deliver similar return and volatility objectives, via different approaches: hedge funds achieve their objective through unconstraining the manager to implement short positions to reduce volatility and enhance returns through leverage; multi-asset funds broaden the investment universe with the flexibility to invest across asset classes.
Unlike hedge funds their tendency towards long exposures make them more directional. However, multi-asset funds are more liquid, have lower operational risks, lower fees and typically do not use leverage, and as such are less exposed to liquidity shocks.
The multi-asset universe is a heterogeneous group of approaches. The common link here is they aim to improve the distribution of returns delivered to an investor through substituting equity risk with credit risk, duration risk, commodity risk and others, in combination with manager skill.
Limiting downside through diversification enables investors to compound capital at a higher rate and, in the long term, achieve a performance similar to the one expected from an equity exposure but with significantly lower volatility.
However, asset exposures are generally directional and have a degree of correlation, and in times of stress correlations increase thereby reducing diversification benefits.
Therefore, one of the key risks multi-asset managers take on is correlation risk. When choosing a multi-asset strategy it is vital for investors to understand how the manager allocates to assets and controls this correlation risk.
Freedom an absolute must
We believe that the key to a successful multi-asset strategy is the ability to invest in a flexible, unconstrained manner and act idiosyncratically to broaden specific risk exposures.
The absence of benchmarks setting neutral exposures allows higher degrees of active management and this flexibility means that the manager skill is an additional dimension to asset diversification that helps achieve superior risk-adjusted returns.
The combination of diversification between risk premia and manager skill provides additional stability to multi-asset funds, and ultimately a better risk/return profile over time. When analysing the performance of multi-asset funds investors must be careful to take into consideration the consequences of taking active risk, appropriate time horizons and benchmarks.
Active risk:
It is not realistically possible for an active manager to be right 100% of the time. Accordingly, periods of underperformance may simply depend on wrong decisions. However well-structured investment processes and risk management techniques add value and the combination of diversification between risk premia and manager skill will provide additional stability to multi-asset funds, and ultimately better outcomes.
Time horizons:
As multi-asset funds invest in a broad range of markets in a directional manner they are exposed to risk factors that may disappoint in the short term. In addition, short-term changes in correlation between assets may have an impact. This is particularly true when risk aversion dominates and correlations increase resulting in higher risk. However, risk premiums do deliver appropriate returns to compensate investors over the longer term. As such, performance of these strategies should be evaluated over at least a three-year time horizon.
Appropriate comparisons:
It is true that specific risk factors are almost always included in multi-asset portfolios (the equity risk being one of them and in the short term may be more relevant than others because equity is more volatile), but the sensitivity of the overall portfolio varies as a result of active management and risk management.
With specific reference to the correlation between multi-asset funds and the equity market, it can be demonstrated statistically that long-term correlation tends to be significantly lower than short-term correlation.
That is because in the short term the correlation between two distributions of return is more influenced by the volatility than the mean (and equity is the most volatile asset class), while this is much less true for appropriate long-term analysis.
The outcome and consequences of policy decisions are wide-ranging and uncertain. Given the scale of intervention the outcome is likely to be exacerbated and could be inflationary or deflationary. Maintaining a flexible multi-asset approach with a long-term investment horizon is a good way to benefit and protect against any likely policy error.
