BNY Mellon Investment Management: Seven things to look for in a multi-asset fund

1. Equities: look under the bonnet

All equity exposures are not equal. In most multi-asset funds, the “heavy-lifting” in terms of capital returns – and increasingly income generation – will likely be done by shares. It is crucial therefore to understand the asset class’s exact composition within the portfolio and where the fund manager is taking risk. This can vary hugely between funds, so advisers should drill down carefully into that exposure to determine the true geographic, sectoral and thematic positioning. This is particularly the case when multiple funds are in play as doubling-up can conceal unintended biases. You could end up exposing your clients to more risk than you thought.

2. Are responsible investment promises being kept?

“Greenwashing” – talking the talk but not walking the walk in terms of integrating ESG-type principles into a business or investment strategy – is on the rise. In order not to be blindsided, advisers need to examine thoroughly the claims made by the fund provider and insist on proof of their delivery. It’s also important, however, for advisers to engage closely with individual clients as one person’s definition of responsible investment will often differ materially from another’s.

3. How do they define “diversified”?

The multi-asset philosophy is built on the bedrock of diversification. But the spreading of risk across asset classes is not a one-way bet as being over-diversified can be just as risky as being under-diversified. Being diversified may mean different things to different managers. Some may define it to be the number of holdings in the strategy while others may base it on the spread of asset classes held. That can have a big knock-on for the risk profile. In any event, the “efficiency” of diversification should be the priority as unplanned-for gaps or overlaps in a portfolio can all too easily translate into unexpected outcomes.

4. Check the profile of historic correlations

When researching multi-asset funds, the need to understand how the strategy performed through different market conditions cannot be underestimated. Careful analysis of performance across one or more economic cycles can give a valuable insight as to how it may navigate trends and market events in the future. One fund, for instance, may reveal itself to be outcome-orientated, aiming for higher returns over the long term, while another may be set up to “manage the journey” by smoothing out the peaks of volatility. If the evidence of history consistently contradicts a fund’s stated objective, then alarm bells should ring. These days, finding funds that consistently meet their mandate is gaining in importance for advisers over mere past performance.

5. Where are the risks being taken?

Be sure to identify where risk is being spent on your chosen multi-asset fund. For strategies with a defined income objective, for example, the plunge in bond yields to almost zero (or below if you were in Europe) forced some fund managers to “up the ante” in terms of risk. That may well have meant sneaking down the credit quality scale in corporate bonds or flirting with potentially combustible value traps in equities, both of which were moves that could have had unpleasant consequences for capital performance during downturns in sentiment. As a rule of thumb, the five Investment Association multi-asset sectors only give a clue as to the scale of strategic risk being deployed. With the sectors concealing a wide dispersion of potential allocations, you may end up with a risk/reward profile you hadn’t bargained for.

6. Static or dynamic allocation?

Although cheaper and easier to maintain, a static “set and forget” asset allocation based on expected returns has proven itself to be something of a gamble in recent years, especially given the breakdown in the correlation between bonds and equities and the volatility seen in equity risk premiums and credit spreads. Multi-asset funds have therefore become much more dynamic but is there a limit to how flexible a strategy should be? Being nimble and responsive can bring greater alpha opportunities and more downside protection when used judiciously but a fund overly active in allocation could suffer higher transaction charges, and constant trading will be likely to have a negative impact on returns.

7. How skilled is the fund manager?

The ‘x’ factor when it comes to choosing a multi-asset fund is the expertise of the fund manager. Can they demonstrate consistency over multiple market cycles? Are they skilled in some asset classes but less so in others? The scope of the multi-asset fund universe demands significant research resource but it is the manager that can show a depth of expertise in key classes that is likely to outshine the one that tries to cover all bases. Culture is important too. A fund manager team that collaborates and shares ideas is likely to blend assets more efficiently than those who sit in silos. The bottom line is that experience and pedigree are essential qualities of your chosen multi-asset manager.