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.

Reduced volatility

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

More about