Achieving the right blend of multi-asset solutions can enhance risk-adjusted returns over the long term.
Salt & vinegar crisps. Gin and tonic. Or for Americans like me, peanut butter and jelly. These quintessential classics that, while on their own are perfectly satisfactory, blend in such a way that the combination results in a mouth-savoury sensation more powerful than if each were eaten separately.
While perhaps not as tempting or addictive, the same analogy can be applied to blending multi-asset solutions. What does that mean exactly? Isn’t a portfolio “blended” enough with a single multi-asset solution given the portfolio invests across different markets?
Beware manager risk
Indeed, while a multi-asset solution may indeed be diversified across asset classes, where it may not be diversified is around manager risk. As the recent incident around Woodford funds illustrates, investors need to be aware of specific manager risk when making investment decisions.
There are a few ways to go about this. Firstly, more rigorous due diligence of managers is required, especially single star managers. Having a strong investment process, one with multiple portfolio managers, should not only foster better and broader idea generation, but also help provide effective checks and balances for the fund.
Secondly, blending different multi-asset solutions can mitigate some of the specific manager concentration risk. Just as it would not be prudent to put all your investments into a single stock, diversifying across different managers represents sensible risk management.
Blending different portfolios should also create a smoother return profile for the investor. For example, take the annual returns below of three illustrative multi-asset portfolios:
Past performance is not a good indicator of future results
It may have been tempting after 2016 to discard the lesser performing strategies and simply keep Portfolio I as the standalone investment solution. However, Portfolio I did not prove to be the best performer in subsequent years. In fact, it was the worst performer of the three funds for the following two years. And Portfolio III, which was the best performing fund the past two years is proving to be the laggard this year so far. This is a clear example of outperformance one year not necessarily materialising the next.
These factors are especially relevant now given we are entering the unchartered territory of the longest-running economic cycle in history combined with an unprecedented ultra-loose monetary policy keeping interest rates depressed and asset prices artificially inflated.
Finding the right blend
The key to blending is to find managers that offer complementary return drivers and risk characteristics. Selecting two passive multi-asset portfolios that invest in the same markets may mitigate specific manager risk but won’t offer many diversification benefits beyond that.
In selecting complementary managers, it is prudent to include analysis on a manager’s:
- Investment universe: Does the portfolio go beyond traditional equity, bond, property markets? If so, which ones and why?
- Strategic and tactical asset allocation approach: Is the SAA outsourced, if so to who? Is there a regional or home bias in the allocation of weights/risk in the portfolio?
- Implementation: Are the building blocks passive, active or a blend – and why?
For example, a passive multi-asset solution with a limited investment universe and a UK home bias might be well complemented with a more active, globally-focused portfolio that also includes a broader range of asset classes, such as credit, small cap equities and other alternatives that generate decent returns and are less correlated to traditional markets.
Unlike with flavour combinations, which are subjectively reliant on individual taste preferences, finding the right blend of multi-asset solutions should work more universally – thereby potentially enhancing the risk-adjusted performance potential of an investment portfolio over the long term.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). As at 25/06/2019. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment.
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