Research has found £22 billion is invested in multi-asset funds that have underperformed over three, five and 10 years.
Multi-asset funds, which hold a mix of equities, bonds, cash, and in some cases property, commodities and more esoteric assets, are among the most popular choices for financial advisers and their clients, and are also used by many self-directed investors as a ‘one-stop shop’.
The idea is that a mixture of assets means investors can enjoy some upside when equity markets are rising, but are protected against much of the downside when they fall.
But new research from Asset Intelligence finds that £22 billion, more than 14% of the £155 billion invested in the three main Investment Association (IA) multi-asset categories is held in funds that are consistently letting investors down, having underperformed their sector average over three, five and 10 years.
Even more worrying, the research also reveals little is being done to improve matters, with £30 billion of funds - almost a fifth of the total – underperforming the sector over consecutive five-year rolling periods. As the report observes: “The figures show that a large number of assets have simply been left to underperform over the long term.”
Of course, different funds have different objectives and will therefore behave differently from peers. For instance, says Gavin Haynes of Fairview Investing, “a more cautious fund (with less exposure to equities) is likely to have underperformed, as equity performance has been strong over three, five and 10 years.”
Haynes makes the further point that there’s huge diversity of funds within each of the three IA mixed-asset sectors (Mixed Investment 0-35%, 20-60% and 40-85% shares).
“You have to be careful comparing multi-asset funds,” he says. “For example, a multi-asset fund with 25% equity will have a very different risk/return profile from a fund with 60% equity, but would still be in the 20-60% shares sector.”
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Nonetheless, there are other factors at work that are underpinning this widespread serial underperformance among multi-asset funds.
A key part of the problem is to do with the mis-labelling of assets, according to Asset Intelligence. Because investment risk in the three IA sectors is defined specifically in terms of exposure to equity markets, it fails to pick up on other relatively risky asset classes such as emerging market bonds and global high-yield bonds.
Yet the fortunes of these assets tend to follow those of global equity markets more closely than they do low-risk government bonds. As Robert Love, principal of Asset Intelligence, observes: “By leaving them out of the fund’s ‘risk’ category, it means investors are left exposed to assets which will act more like equities but which they assume are giving them protection.”
A second aspect is the fact that these funds tend to be significantly overweight the UK. The report shows that all three mixed-asset sectors have around 20% or more of their equity holdings in the UK, yet the MSCI All World Index has nearer 5%.
As Haynes points out, that has worked against those with the highest UK exposure. “The UK has been an underperformer versus global equities, so remits that have high weightings to domestic shares will have struggled over three, five and 10 years.”
Asset Intelligence’s report concurs: “Structurally, funds shouldn’t have this level of bias to the UK … it has cost investors returns, as well as exposed their portfolios to swings in prices.”
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Third, there is the issue of how far multi-asset funds are being truly actively managed. According to the report: “Now, more than any time in recent memory, a defaulting to generic market access is highly problematic.”
That’s a reflection of the fact that assets are generally expensive now, which means they no longer have the capacity to deliver stellar returns in future. In such conditions, canny asset selection can make all the difference.
“The critical point is not that multi-asset funds don’t use active management (as many do), but that in lots of cases, investment selection rigour has disappointed, with active management failing to add value to the bottom line and to generate excess returns for clients,” it concludes.
These problems have been compounded by the fact that inertia is so prevalent among investors in these funds: the amount of cash still sitting in chronic underperformers is testament to that.
“These funds are sold as ‘ready-made portfolios’ and the danger is that investors can be complacent and do not regularly monitor their performance against that of peers,” suggests Haynes.
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He adds that a number of multi-asset funds have been launched and run by advisory firms themselves, and sold directly by banks and life companies; “it is questionable whether the advisers will tell their clients to sell, even if the funds underperform,” he comments.
So what would a high-quality multi-asset fund look like?
As well as delivering attractive returns with reduced downside, it needs to be flexible and able to adapt to the investment environment, says Haynes. “This is particularly important at present, with bond markets currently looking unappealing given low yields, diversifying across other areas such as property, infrastructure and commodities could be prudent.”
Asset Intelligence wants to see an overhaul of multi-asset funds. This would include “true diversification”, with the IA sectors relabelled so that all the risk focus is not on equity exposure alone. It would also embrace a more global perspective on portfolio construction, and “truly high-quality active management” involving “insight and precision”.
Will the industry respond to the challenge? Time will tell; investors are clearly being short-changed as things stand.
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