Should you opt for a diverse approach?
In the aftermath of the financial crisis, the idea of funds that offer instant, managed diversity across a spectrum of asset classes appears to have caught the public's imagination.
Indeed, earlier this year many financial advisers and other industry commentators were citing these multi-asset funds as the product most likely to attract investors in 2010.
Meanwhile, the industry has helped fuel consumer interest with a constant stream of multi-asset launches over the past 18 months, including the IFDS Frontier MAP Balanced Fund, SWIP's Optimal Multi-Asset Fund, Prudential's new stable of multi-asset funds and, most recently, a couple of multi-asset offerings targeting absolute returns from Rathbone.
The big selling point for these funds is their capacity (in theory at least) to reduce overall volatility in the face of market swings.
They do this by combining a wide selection of assets - equities, bonds, property, commodities, cash, hedge funds, private equity - whose fortunes don't correlate perfectly, so that when one is suffering, another may remain relatively unscathed.
However, as Martin Gray, manager of the CF Miton Special Situations fund, observes: "Although diversification is an excellent theory, it doesn't work when there's pain all around, as there was in 2008."
Nonetheless, multi-asset funds were able to provide relative protection in the downturn, falling in value but by markedly less than their equity-based peers.
Gray's fund was one of the very few to make money during that year, mainly because he moved presciently into cash and sovereign debt.
Multi-asset funds can be particularly valuable for smaller and DIY investors as a cost-effective means of accessing a level of diversity previously only available to wealthier clients.
Julie Lord, wealth manager at Bluefin Wealth Management in Cardiff, says: "For clients with up to £150,000 or so, I use a fund that provides maximum exposure to different asset classes. For portfolios above that size, we do the asset allocation ourselves."
Additionally, says Steve Laird, principal of Carrington Wealth Management: "Most of these funds target returns above either inflation or cash, which clients find relatively easy to understand.
"Moreover, asset allocation is key to their performance, so it is harder for the managers to hide behind a strong market performance, which I like."
Pick a winner
However, it's important to recognise that multi-asset comes in a number of guises, so you need to understand what you're investing in. For a start, the division between passive and active management is as prevalent here as elsewhere in the industry.
Some multi-asset managers remain stockpickers - or at least manager pickers - at heart: they make their asset allocations primarily using actively managed sub-funds, with a focus on identifying "best of breed" managers.
David Hambidge, who runs Premier Asset Management's three multi-asset funds, is one such manager.
"We don't use tracker funds or exchange traded funds much. We have used them for gilts, where it's very hard for active managers to add value, and we also employ them for very short-term holdings to get exposure to a particular market while we're identifying a suitable actively managed fund, but basically I'm actively inclined," he says.
Gray also favours actively managed funds. "I'm holding three or four ETFs out of a portfolio of 50 holdings," he comments.
"I use them especially in volatile markets like this one because I can press a button and sell out of a market at that point, whereas with unit trusts the sale might not go through until the following afternoon.
"But generally I want active funds because if I'm bullish on Japanese equities, say, I want the manager most likely to perform on the upside."
But other managers, including Frontier and 7IM, don't worry much about individual stock selection and instead focus on optimising returns through asset allocation while keeping costs down. To that end, they make use of index tracker funds, ETFs and stock baskets.
Finding the right mix
Multi-asset managers also adopt a variety of approaches in allocating and managing the constituents of their funds.
Strategic managers such as Frontier aim to establish an optimal blend of assets as a benchmark for a particular risk profile.
They look at levels of long-run risk and return for each asset and how that trade-off can be boosted by combining asset classes.
The portfolio can be regularly rebalanced by selling down the asset classes that have outperformed and increased in proportion, and buying up additional allocations of underperforming asset classes.
Because asset allocation counts for everything, Frontier uses the same optimal balance of eight assets for all of its onshore fund options, accessing each by using low-cost index-tracking investments.
That means the whole lot can effectively be treated as a single fund, helping to reduce costs further.
Tactical managers focus on the macro-economic and shorter-term market opportunities, typically by tweaking or overlaying a strategic long-term view on asset allocation with tactical manoeuvres in order to seize the moment.
For example, Trevor Greetham, manager of Fidelity's Multi Asset Strategic fund, employs a strategic benchmark of 50% bonds and cash, and 50% growth-oriented assets (property, commodities, plus global and UK equities), investing in actively managed Fidelity funds.
Then he has leeway of 10% in either direction for tactical movements within each asset class. "It's like being a stockpicker, but aiming to add value by looking at markets rather than stocks," he says.
Contrarian managers look for unloved or good-value asset classes and allocate accordingly, so they need reasonable flexibility to respond to opportunities.
They tend to make use of actively managed funds in order to grasp the best opportunities within those asset classes.
As Premier's Hambidge points out: "We don't want to box ourselves into a corner by having to rebalance to a predefined model - we need wiggle room in order to add value."
The strategic multi-asset approach is less prevalent among investment trusts and companies, perhaps because independent financial advisers (who are showing increasing interest in multi-asset funds as a way of outsourcing the allocation and management of diversified client portfolios) tend not to use them much.
However, Simon Elliott, head of investment company research at stockbroker Winterflood, picks out a few trusts that hold a range of asset classes.
"Bramdean Alternatives, which was taken over by Aberdeen Asset Management last year, is a fund of specialist trusts in areas such as private equity and hedge funds. It provides access to a mix of alternative assets," he says.
RIT Capital Partners and Ruffer Investment also run mixed-asset portfolios. RIT in particular holds a wide range of asset classes, including unquoted shares and currency positions. However, as Elliott observes: "It invests entirely where it wants to."
There is no obligation to follow particular asset allocation strategies. Iimia Investment Trust, a trust of investment trusts, is also broadly diversified, but again without any preconceived multi-asset strategy.
Umbrella funds such as Invesco Perpetual Select and JP Morgan Elect offer at least some diversification. These trusts offer a range of four or five portfolios, and investors can switch between them without having to crystallise capital gains.
Elliott suggests that this kind of arrangement may become more popular, given the likelihood of a capital gains tax hike.
This article was originally published in Money Observer - Moneywise's sister publication - in July 2010
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.