11 Mar 2023
Multi-asset investing has come a long way since the days when the 60% equity – 40% fixed income portfolio was the only game in town for diversification-seekers. Today, the marketplace has become markedly more sophisticated, with fund managers selecting from a rich array of assets. But have these funds become too complex for their own good?
It cannot be denied the classic 60/40 portfolio has been a successful formula for investors down the years. It’s proven to be a simple, understandable and, with low turnover, cost-effective option for steady capital growth with lower volatility over the long term.
But now there’s a problem. The role of bonds as a natural buffer to equity-market volatility has been all but extinguished by quantitative easing’s distortion of the financial markets since the 2008 global financial crisis (GFC). This mattered little while central banks were in full money-printing mode as even government bonds, despite paltry yields, produced some truly stellar capital performance. However, as bonds moved into lockstep with equities, they shed their qualities as a backstop in times of crisis. As quantitative easing has morphed into quantitative tightening, total returns for bonds have lurched into a tailspin, leaving 60/40 investors to nurse some notable losses in the last year or so.
To make matters worse, the medium-term backdrop for 60/40 is not encouraging. The global economy is expected to enter a phase of lower growth, while higher inflation is starting to sap the economic life-force that is consumer spending. Uninspiring dividends and rich equity valuations complete the somewhat dispiriting outlook for an investment formula that typically only thrives when growth is on the up. So, with 60/40 funds seemingly poised to produce noticeably lower returns compared to long-term averages, can multi-asset funds step into the breach?
Following the publication in the 1980s of research by Brinson, Hood & Beebower suggesting active asset allocation, not security selection or market timing, was the main driver of investment value, funds that switch dynamically between multiple assets classes began to increase in popularity. From the early 2000s their proliferation rose as the stinging losses brought about by the GFC forced investors to look at more diversified solutions offering better protection for capital.
The low-yield/high-volatility reality of the post-GFC environment spurred fund managers to investigate new ways of meeting investors’ objectives. This brought about the launch of products that sought to use a diverse yet complementary blend of assets to combine capital growth with downside protection and competitive income generation. Upending the rigidity of the old 60/40 model, the new multi-asset funds sampled a new spectrum of assets, a number of which were specially designed to play a defined role in those unconventional times.
The blossoming of multi-asset saw a new emphasis on equities, with fund managers tasking them with income-generation duties to complement their traditional role as the cornerstone of capital growth. Once alternative assets such as real estate investment trusts (REITs) and commodities were added to the mix and an active asset allocation framework applied, the familiar globally diversified balanced portfolio had evolved into something far more responsive and dynamic.
In launching suites of multi-asset funds, typically graded by risk, fund managers sought to meet the rapidly evolving needs of investors. The traditional 60/40 portfolio had functioned largely as a generator of reliable, low-volatility growth and income for people approaching retirement. However, that model was no longer appropriate for younger investors, who were in need of stronger early-years growth to compensate for the withdrawal of both state pensions and generous final salary company schemes, and also for older investors, who were looking for higher income to maintain their standards of living as life expectancy rose. By dipping into the increasingly varied and thematically layered multi-asset market, investors were enabled to create a blend of strategies to neatly match their changing circumstances and aspirations from almost cradle to grave.
But could the “überdiversification”, now a feature of some multi-asset funds, actually be self-defeating? Could trying to cover too many bases mean that fund managers end up covering no bases at all? There is, after all, such a thing as too much diversification.
Complexity also compromises transparency. Investors typically gravitate to strategies that are easy to grasp, while the opaque mechanics of some of the more specialist assets risk being alienating. Today, people increasingly want simplicity.
Cost is a further unwelcome byproduct of complexity. Trading in fringe assets that are not widely understood may also attract higher fees (not to mention low relative liquidity), while the extra resources required for research and analysis risk pushing those ongoing charges into the red zone.
At Newton, we believe there is no blanket formula for success that can be applied across multi-asset funds given the variety of roles they are expected to perform. The sector is simply too diverse and wide-ranging. So instead of trying to cast our net too wide, we focus on understanding company fundamentals because it is here we expect to find the best opportunities for capital growth and income.
The investable universe and client expectations have evolved to such a degree that we need to start thinking in different terms.
The value of investments can fall. Investors may not get back the amount invested.
Important Information
For Professional Clients only. Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes.
For further information visit the BNY Mellon Investment Management website. http://www.bnymellonim.com