Multi-asset centre ground or core-satellite barbell approach?
Buying into popular investments like multi-asset funds may seem appealing to clients but would a more bespoke approach be better for your business? Independent Discretionary Fund Analyst Adrian Mill examines both approaches
It can be easy for clients and investment professionals alike to forget that discretionary portfolio management is just that – discretionary. How funds are categorised and labelled is not set in stone and wealth managers can stand out from their peers in the way they manage clients’ money. They can do things rather differently.
I believe that although alpha generation, net of fees, for actively-managed funds seems to be increasingly difficult to spot, it does exist. There is a strong argument for being contrarian but this approach may take time to yield results and in the meantime many investors have short time-horizons. They feel less exposed when their money is invested in more popular funds, yet in bearish markets these may tend to have a more pronounced clustering around a beta coefficient of 1 because managers move to the centre ground. If active funds become closet index-trackers, then their fees may not be worth paying.
Imagine a client with a modest investment with an average risk appetite over a three to five year investment cycle. On a scale of one (low risk/reward) to five (high risk/reward), this person would be a three. If they were high net worth, a suite of funds could be purchased across asset classes to average out risk and reward. This would provide diversification and larger investment sizes would permit more tactical asset allocation and switches as and when required.
A smaller investment may not be able to have access to many specialist funds across asset classes; one way this problem can be overcome would be to invest in a multi-asset fund. Recent years have seen a growth in multi-asset funds, ones where managers can invest in bonds, equities, cash products and even esoteric asset classes such as property and maybe hedge funds via investment trusts. This broad spectrum of investments seems very appealing and on the face of it would seem to provide an elegant solution for investors with less money.
Questions for the multi-asset manager
However, there are some questions beyond the usual quantitative and qualitative examination:
• can a manager possibly know as much about each asset class as the others?
• how many analysts are there to help the manager wade through so much data?
• how good is the manager at understanding the macro environment?
• people agree that investing across asset classes aids diversification and the reduction of risk. Do they realise that returns could be diversified too?
Studies have shown that asset allocation provides a greater proportion of returns than stock selection. A specialist fund manager should know their market inside out and stocks would be picked according to the mandate, for example Growth or Value and so on. A multi-asset fund manager has so much to consider. Maybe too much? Picking underlying funds and/or stocks would likely take up considerable time, yet most of the returns would come from over- or under-weighting classes and sectors and it would be important to know if sufficient time was being dedicated to the macro side of things.
Core-satellite barbell approach
An alternative way to generate an average risk profile for the client could be to undertake a core-satellite barbell approach to allocating investment. This would allow portfolio construction on a more bespoke basis for a client and the ability to reposition the portfolio should the client’s circumstances change.
The financial turbulence of recent years spawned a host of open-ended absolute return funds. These aim to maintain capital preservation in all market conditions and have become popular as their structures mean that the negatives of hedge funds can be avoided, namely redemption notice periods and illiquidity issues leading to gating and/or the creation of side-pockets.
A core position could be in one or more such absolute return funds.
Some positives of these absolute return funds are:
• units can be bought and sold as a regular unit trust or OEIC
• the potential for a large universe of funds as they can be sector or region neutral. A manager can create pairs trades in stocks within different regions of the world – this means that regional weighting risk is mitigated
• managers with strong track records can be identified and allocated to based on their skill and not investment region covered.
However there are some negatives associated with the funds:
• some fund managers who had been long-only specialists started to run absolute return funds. The skills to identify suitable short stocks are not just as straightforward as a long-only manager having a bearish stance on stocks
• pairs trades within a sector are made to create alpha due to the manager’s ability, but this sector neutrality means that opportunities to exploit macro changes cannot be harnessed.
Determining the risks
A wealth manager, or the firm to which the task was outsourced, would determine the risk of various funds using different quantitative ratios, including the beta, ie the sensitivity to the market. Once the core absolute return and cash position has been created, then smaller allocations to satellite funds of a more speculative nature may be made. The considerations here are:
• if an investment manager has conviction about a speculative growth fund then a large amount of alpha may be generated by a fairly small investment
• a small investment would help limit the downside risk because of its size
• if two satellite positions were taken, one with a beta of 1 and the other of -1, then they should provide balance if there is temporary uncertainty
• a core-satellite approach would permit tactical tweaking
• investing at an institutional level would permit fees to be negotiated to very low levels and so the cost of switches should not be too much of a factor.
The route taken in this example depends on the conviction of the investment manager to back their views on the macro calls. Buying a multi-asset fund would be the safer option in the sense that the top-down decisions would be outsourced but there are some interesting funds out there and if a wealth manager can identify areas to overweight then exercising discretion could be the way to go.
Adrian Mill has experience of fund selection within private banks, wealth management boutiques and consulting.