Is multi-asset a mug’s game?

Only a fraction of multi-asset funds outperform passive alternatives

A debate has erupted among advisers over the worth of multi-asset funds after research branded investors holding costly poorly-performing funds as “mugs”.

The report by research consultancy Finalytiq looked at 89 multi-asset fund families and concluded that an overwhelming majority of funds do not add any value over and above simple “no-brainer” portfolios of equities and bonds rebalanced annually.

Report author and Finalytiq founder Abraham Okusanya (pictured) says the results show that with a very few exceptions multi-asset funds are a “mug’s game”.

The research used FE Analytics data over one, three, five (see chart below), seven and 10 years to compare the risk-adjusted returns of multi-asset funds against a series of 10 portfolios with allocations to risk assets ranging from 0% to 100%.

Source: Finalytiq

Based on the funds’ size-weighted Sharpe ratios, it found 34 out of 79 multi-asset fund families outperformed passive portfolios over a three-year period, 10 out of 71 over a five-year period, 11 out of 62 over a seven-year period and nine out of 41 over 10 years.

Number of fund families per observation period

Number of fund families that outperformed ‘no-brainer’ portfolio benchmarks on a risk-adjusted basis

Source: Finalytiq

“We can conclude based on this metric that the fund families demonstrate sub-optimal asset allocation and ineffective asset selection,” the report says.

Multi-asset proponents hit back

But Royal London Asset Management head of multi-asset Trevor Greetham argues that multi-asset funds offer a better risk-return trade off and that including asset classes other than equities and bonds provides greater resilience. Greetham’s ‘investment clock’ (see below) offers an insight into asset classes and sectors that outperform during certain phases of the cycle.

“Theory suggests a diversified multi-asset portfolio is more efficient and should offer a better return for the same level of risk and historical analysis shows lower peak to trough losses during market stress,” he says.

“Commodities do better during a geopolitical shock like the 1990 invasion of Kuwait and tend to outperform when global growth is strong and inflation is rising. Domestic property rose during the 2000-2003 equity bear market.”

Commodities tend to outperform during the overheat phase of the cycle

Scopic Research managing director Paul Ilott agrees that in theory, having exposure to more asset classes within active multi-asset portfolios when compared to the typical equity-bond passive portfolio, should help to diversify both sources of risk and contributions to returns.

“During those risk-off market periods when both equities and bonds become highly correlated with one another, a more diverse portfolio has the potential to perform better in relative terms,” he says.

“But, when equities and bonds are highly correlated during more positive market periods, alternative type assets in a diverse portfolio are likely to hold the portfolio back from making stronger gains – particularly since alternative assets are likely to have been selected as a hedge due to their lack of correlation of returns to traditional assets.”

Managers worth more than advisers?

As well as risk-adjusted returns, the study considered gross returns, total costs and the combined maximum drawdown and maximum loss factor and gave funds a rating from A to E. The study identified three As, 13 Bs, 13 Cs, 16 Ds and 40 Es.

Fund family scores and cost range

Source: Finalytiq

On fees, it found at 1.15% the median total fund cost of the multi-asset fund sample is greater than the typical advisory fee which is 1%. It said low-cost propositions available through Vanguard, Blackrock and a few others tend to deliver better returns for clients. Vanguard Lifestrategy was awarded an A rating based on strong annualised returns and its “impressive” 0.27% cost.

“Given their dismal performance, it is quite worrying that asset managers seem to believe that they’re worth more than advisers,” the study says. “It is even more worrying that advisers who recommend these funds appear to buy into this myth.”

Planworks director Nathan Fryer says the portfolios he is connected to typically use Vanguard Lifestrategies as a benchmark to measure performance.

“If you can’t beat that, and you’re an active manager, then you can’t really warrant the additional fees that are being charged,” he says.

But Fryer notes that the return targets for multi-asset funds do vary widely, meaning a comparison with a straight equity-bond portfolio is difficult. “If you’ve got a portfolio that says we will deliver x% return over a rolling period of y then it’s probably an unfair comparison.”

The value of tactical allocation

Greetham accepts comparing multi-asset funds with a simple passive balanced fund does raise questions over cost, diversification and active management, but overlooks the potential to add value through tactical asset allocation.

He says both stocks and bonds have enjoyed a tremendous bull market over the five-year period in question with returns especially good in sterling terms. But he says both asset classes are now expensive, so history is unlikely to repeat itself.

He adds: “Active tactical management is particularly important when return expectations for buy and hold strategies are muted, as they are now. Our analysis shows [tactical asset allocation] adds more value in bear markets than bull markets, so it can also be a source of risk reduction as well.”

Fixed income duration

Another element to consider is how bond duration has affected performance in these portfolios. Portfolio Adviser previously highlighted the soaring duration of Vanguard’s Lifestrategy range and how this exposed investors to underperformance in a rising rate environment.

Ilott says with expectations for interest rate levels now lower, the bond allocation in a simple passive equity-bond portfolio has benefitted from a naturally longer duration positioning.

“In contrast, many multi-asset managers have been cognisant of the very low and sometimes negative returns now on offer from sovereign bonds in particular if held to maturity – especially having accounted for inflation and the costs of investing – and have either adopted short duration positions or have replaced some of their bond exposure with alternative investments that they believe are more likely to weather any future normalised interest rate conditions.”

Ilott adds in recent years, these positions have often held back returns relative to the typical equity-bond passive portfolio.

Central banks buoy equity/bond portfolios

Looking ahead, Ilott believes it is possible that the typical equity-bond passive portfolio will struggle in relative terms should investment markets stop being driven by central banks, politicians and currency movements and investors begin to value the importance of fundamentals, including price and liquidity.

He says: “Should expectations for inflation spike, equity and bond allocations within passive multi-asset portfolios will suffer and the more diverse exposures within multi-asset portfolios should help to buffer their returns from sharper falls.”

Fryer adds: “It just enforces the fact that no one’s really got a crystal ball, no one knows what’s going to happen and no one can anticipate where the market’s going. So, are we paying active management fees for underperformance?”

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