The Evolution of Multi-Asset Funds
Updated: May 20, 2022
To understand why multi-asset funds have evolved it is vital to understand two key things about traditional balanced funds: first, how they define diversification and second, how they define their performance objectives. Diversification in balanced funds is typically considered in terms of the distinction between ‘growth’ and ‘defensive’ assets. The general premise is that investors should reduce their exposure to higher growth, riskier assets (such as equities) as they approach retirement and move to less risky, more defensive assets (such as fixed income).
"Population ageing is a well-recognised trend"
Traditional balanced funds generally define their performance objectives in the same way as many managed funds, with fund returns measured against a benchmark and compared to peer rankings. This is not a problem when markets are performing well, but in times of market downturn, managing a fund to a benchmark which is performing badly, or comparing fund performance to peers whose returns are also negative, does not deliver optimal outcomes to investors.
Since the onset of the global financial crisis (GFC), the limitations of traditional balanced funds have become clear. In the years leading up to the GFC, most balanced funds – with their higher, fixed weighting to growth assets – consistently delivered positive returns.
However, since 2007 markets have been much more volatile, and investors have experienced more prolonged periods of volatility than at any time over the previous 25 years. Most balanced funds split their portfolios rigidly between just two asset classes – equities and fixed income. While the typical heavy weighting to equities worked well when equity markets were strong, the lack of true diversification became problematic when equity markets fell. The relatively static asset allocation of these funds also proved unsuitable during periods of higher volatility and lower returns.
Traditional balanced funds face risks
Of course, short-term volatility and lower returns are not the end of the world for those with a long-term investment horizon – for example, those in the ‘accumulation’ phase of their investment lifecycle, with the capital to support their short-term needs and time to wait for markets to recover.
However, investors with a shorter-term investment horizon, such as those heading towards, or in, retirement, are particularly hard hit when fund values fall. Demographic factors have also thrown a spotlight on the potential problems of balanced funds. Population ageing is a well-recognised trend, with more than five million Australian baby boomers predicted to retire over the next 15 years. Concurrently, life expectancy is increasing, so people are living longer and spending more years in retirement. From an investment perspective, this means a growing number of people with a shorter-term investment horizon (ie those heading towards, or already in, retirement) who face particular risks when investing in balanced funds:
· Longevity risk – the risk of retirees outliving their savings
· Investment risk – the risk of losing money in volatile markets
· Inflation risk – the risk that the value of assets or income will be eroded by inflation
· Sequence risk – the risk that retirement occurs during a period of low market returns, thus adversely affecting a retiree’s ability to fund a given income in retirement.
The experience of the GFC and subsequent volatility, coupled with a growing number of people moving from the accumulation phase to the retirement phase, brought many of these risks to the fore. This served to highlight the shortcomings of the ‘one-size-fits-all, set-and-forget’ approach of traditional balanced funds, leading directly to the introduction of a new style of multi-asset, outcome-based funds.
Flexibility of multi-asset funds provides potential for better risk-adjusted returns
As the name suggests, these multi-asset funds focus on delivering specific outcomes for investors. Some have an absolute return objective – for example, delivering a return over an inflation or cash rate. Others may target a specific yield. Unlike traditional balanced funds, risk is not managed by setting allocations to growth and defensive assets, but rather by taking into consideration what is an acceptable level of risk given the overall objective and constructing a portfolio of diversified assets to meet the objective.
Because these funds are not restricted by explicit asset allocation limits imposed by a benchmark, or more subtly through the pressure of competing against peers, there is greater flexibility and potential for better risk-adjusted returns because allocations to asset classes can be adjusted according to market conditions.
Outcome-based multi-asset funds help to better align investors’ own investment objectives – typically around delivering for current or future lifestyle needs – with the objectives of the funds in which they’re invested. They aim to provide greater certainty in achieving desired results and express risk in terms that relate more directly to outcomes.
While multi-asset funds may not be suitable for all investors, for those with clearly defined growth targets or income needs who prefer a fund that actively tries to manage the short-term volatility of markets, they represent an attractive option.
Published in Aberdeen marketing
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.