In its European Multi-Asset Funds: Rethinking Asset Allocation and Market Timing in Volatile Times report, Fitch argues that a blended qualitative and quantitative approach appears to be most appropriate to meet today’s challenges.
The ratings agency noted that European-domiciled multi-asset funds’ performance improved during the third quarter of the year, with average three-year returns in the Lipper Global Mixed Asset category meeting investors’ expectations and/or asset-liability matching requirements better than they did in 2011.
However , the funds still fall “significantly” short in these aims over five years, Fitch added. “Surprisingly, flexible allocation funds that have larger latitude in their investment decisions have been doing particularly poorly on average,” the agency said.
“Volatile markets without clear trends have impaired tactical asset allocation and funds’ diversification has suffered from a rise in asset class correlations.”
Fitch said fund managers have started to re-assess their portfolio construction processes and use risk budgeting to safeguard against undue risk concentration. The use of methods such as maximum diversity or the minimum variance approach allow them to avoid pure judgement calls.
However, the agency pointed out that such quantitative, rule-based portfolio construction rely on past volatility. At the moment, this has led allocation weights to lean towards fixed income, placing funds at risk should global interest rates rise. Furthermore, high beta stocks could outperform in a more stable macro environment.
Fitch therefore recommended that multi-asset funds adopt a qualitative overlay to help capture structural changes or market overreactions. “Managers with a blend of qualitative and quantitative approaches seem best positioned to meet allocation and market timing challenges in multi-asset funds,” the agency concluded.
