Correlation
The components of a multi-asset fund may look like it is well diversified, but it could be that in fact all of those assets will rise or fall in certain market conditions.
Mr Harman points out, for example, that the following assets have similar characteristics in stressed markets:
- UK equities.
- Global equities.
- Emerging market equities.
- Listed property.
- Corporate credit.
- High yield credit.
He says it doesn’t matter that one asset might fall less than another, as that is irrelevant for an investor who needs to achieve a specific return to meet their goals.
“Nowhere is this misperception of risk more acute than in the fixed income market,” he observes.
“Investors tend to think of fixed income as very defensive because that has been the case historically. However, today, parts of the fixed income market have a zero return and don’t seem very defensive at all, particularly in a climate of rising inflation.”
This is why it is so important for the manager of a multi-asset fund to take a flexible approach, shifting exposures as and when they see opportunities to do so and keeping the financial adviser informed of any major changes to the portfolio.
As Kevin Doran, chief investment officer at AJ Bell, puts it: “To build truly diversified investment portfolios, the investment case must be made first with diversification built in using only those asset classes.
“This is most pertinent at the moment in low-risk, cautious portfolios, where modern portfolio theory and rules of thumb lead investors to bond-heavy allocations.”
He warns: “This is despite the risk of bonds doubling in the past 20 years, during which time the expected returns have fallen by over two-thirds. In our view, surely cash and portable alpha strategies are potentially a better option here.”
For better or worse
Mr Hanson reiterates it is not the number of holdings in a multi-asset fund that is important but, rather, how they relate to one another.
For this reason, a well-diversified fund could be one with very few securities or equally it could be one with more than 50 holdings.
Mr Potter notes: “What you are really aiming for is a fund that can take on the rougher times in investment markets by having some more defensive assets, as well as some riskier components that allow the portfolio to generate good returns in the better times for markets.”
He summarises what ‘good’ might look like in terms of diversification: “A good multi-asset solution will have these disciplines at its core, but where a manager is additionally able to nudge the risk up in good times and down when the waters get a little choppier by adjusting the mix of assets appropriately, is also a good feature.”
