Active Versus Passive: is it Different for Multi-Asset?
Updated: May 17, 2022
I have noted in my investment letters that in the multi-asset space, funds tend to do better in relation to their passive equivalents than is the case in the equity space. Why is this?
"This provides a pretty simple way of adding value to portfolios by avoiding Gilts"
While passive equity funds have been around for decades, passive multi-asset funds are a relatively recent phenomenon. That said, the fund ranges that do exist such as Vanguard’s LifeStrategy and Blackrock’s Consensus have grown quickly and are now big. Since these funds naturally comprise equity content, they represent an evolution within the passive arena rather than something fundamentally different.
Perhaps what held them back for a time was the fact that the creation of passive bond funds, the other main natural component of a multi-asset fund, faced challenges. Bonds tend to trade ‘over the counter’ and appropriate bond indices may not have existed.
However, this challenge has been overcome and the Vanguard LifeStrategy 40% Shares fund now invests in its own passive bond funds that track indices such as the Bloomberg Barclays GBP Non-Government Float Adjusted Bond Index.
Unlike passive equity funds however, there are two elements to the ‘passivity’ of passive multi-asset funds. The components of, say, the aforementioned Vanguard LifeStrategy fund will be passive, but the allocation to each of the components will also be passive (fixed).
For example, the fund’s allocation to UK Equities is fixed at 9.9% and is invested in the Vanguard FTSE U.K All Share Index Unit Trust. In other words, like active multi-asset funds, passive multi-asset funds comprise both asset allocation and stock/bond selection elements. In the case of passive funds however, both elements are passive.
What makes passive multi-asset funds different to their single asset class equivalents is that the benchmarks they track are customised. While some index providers have created composite multi-asset indices, they have not been widely accepted by passive fund providers, who prefer to create their own.
Which brings us back to the original question raised about why active multi-asset funds tend to do better than their single asset class cousins in relation to passive equivalents.
I have a couple of ideas as to why this is.
First, it may be that it is easier to add value through tactical asset allocation than it is through stock selection. We already know that the majority of actively managed equity funds underperform their benchmark or passive equivalent. Tactical asset allocation however may not be subject to the same biases that cause problems for stock pickers. For example, if you know that the yield on the 10-year inflation linked Gilt is -2%, you know that your real return is likely to be around -2%. This provides tactical asset allocators with a pretty simple way of adding value to portfolios by avoiding Gilts.
Second, I wonder if by focussing on tactical asset allocation, active multi-asset funds may be happier to employ a more passive approach at a stock selection level. This might mean that their equity components do not underperform in the same way that pure equity funds might.
Another reason is that active multi-asset funds can invest in investment trusts that invest in property, infrastructure, aircraft leasing, direct lending and music royalties. There are no indices that comprise all these areas, so passive multi-asset funds tend to remain simple balanced structures.
Published on LinkedIn
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.