Taking a flexible approach to turbulent markets

17 April 2020

Since the announcement of the COVID-19 pandemic, stockmarkets have been at their most volatile since the Global Financial Crisis (GFC) and interest rates at record lows, making it difficult for investors to know where to allocate their assets. 

As at 9 April, the ASX 200 had fallen 18.3% as global markets plummeted as a result of COVID-19 while the Reserve Bank of Australia (RBA) had cut interest rates at 0.25%, a record low for Australia. The move was replicated in other countries with the Federal Reserve in the US moving to a target range of 0% to 0.25% and the Bank of England cutting rates to 0.1%.

Speaking after the cut, RBA governor Philip Lowe said the country could expect this rate to be in place for around three years. In order for rates to be raised, Lowe said, he would want to see the virus contained, the market to be in a recovery phase and progress being made towards full unemployment and the inflation target.

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The struggle faced by investors is the same for fund managers – equity managers are struggling with falling stockmarkets while bond managers are on the hunt for yield in a low-rate world.

However, in the multi-asset space, managers have the benefit of a flexible mandate and the ability to go ‘anywhere’ in the hunt for returns. 

MULTI-ASSET FUNDS

There are two main types of multi-asset funds; a balanced fund across various levels of the risk spectrum such as conservative or growth and an objective-based fund which will have more flexibility in assets in order to achieve a specific return. 

Balanced funds usually hold a specific percentage of assets depending on their mandate which cannot be altered past a certain range such as 40% to 70% in equities and 20% to 40% in fixed income depending on their risk profile. 

On the other hand, an objective-based one will have a much wider remit in terms of assets it holds and percentage of assets and can use alternative assets such as hedges, gold and property in order to achieve its target return.

According to FE Analytics, within the Australian Core Strategies universe, there are over nearly 600 funds in the six different mixed asset sectors with the most popular sectors being 118 growth funds and 107 balanced funds. 

Over three years to 31 March, 2020, the average mixed asset fund had returned 1.9% with the best performance coming from the mixed asset – moderate sector where funds had seen average annualised returns of 2.2%.

Across the six different sectors, the best funds of each were Australian Unity Wingate Spectrum with annualised three-year returns to 31 March, 2020, of 7.2%, Zurich Money

Maker Series Managed at 6.2%, Macquarie Multi-Asset Opportunities and IOOF MultiMix Growth at 5.9%, Macquarie Life Capital Stable at 5.5% and Perpetual Growth Opportunities at 3.9%. 

Simon Doyle, head of multi-asset at Schroders, said there had been an increase in objective-based funds in the last 10 years. 

“The GFC re-focused people’s minds on liquidity as they realised equities could go down as well as up. It became about delivering against objectives, not just the peer group,” Doyle said.

“There can be a lot of wealth destruction done during this volatile period and having an objective-based portfolio reduces that variable.”

State Street’s senior investment strategist Raf Choudhury said: “While investors have experienced strong market returns since the GFC, they learnt hard lessons. Arguably the most important lesson was that correlations are not stable. 

“This is significant because investors often rely on the diversification between asset classes to manage risk but diversification only works when correlations are consistently low or negative.

“This leads us to the asset class loosely described as ‘alternatives’. We don’t believe traditional assets alone will deliver the return or risk management characteristics that investors need so investors globally are searching for new assets.”

Al Clark, head of investment at MLC, said: “We run diversified accumulation funds which are growth/defensive split. Then we have objective-based funds and they are run in a distinctly different way. When we think about accumulation, they are more return-focused whereas the objective-based ones tend to be more risk-focused and minimise risk”.

Over at Insight Investment, Bruce Murphy, director for Australia and New Zealand, described the firm’s multi-asset approach as the ‘three Ds’.

“For us, it’s about the three D’s of diversification, dynamic asset allocation and downside risk management,” he said.

HOW THEY HAVE POSITIONED FOR COVID-19?

The first move when COVID-19 looked like it could become widespread, most managers said, was to reduce equity exposure, in some cases to as low as 5%.

Kej Somaia, co-head of multi-asset solutions, at First Sentier Investors, said he had been making incremental changes to the asset allocation of his First Sentier Real Return fund since January.

“We reduced our equity exposure to 47% in January because we were concerned about the spread of COVID-19 with people travelling around Asia around Lunar New Year.

Then the situation changed dramatically and we brought it down further to 30%,” Somaia said.

Murphy said the Insight Diversified Inflation Plus fund had gone into the crisis with almost half of the portfolio invested in equities but had cut that dramatically. The fund had lost 12% since the start of 2020 to 8 April. 

“We went into the period with reasonably high equity levels and by the end of February, we had cut that to 11%. Now we are at 5% which is the lowest we have been in a long time,” he said.

Next up was the allocation to fixed income and adjusting the duration, which the managers said was a key differentiator as these type of funds were usually not aligned to a particular index.

“The remainder is in fixed income such as government bonds but it is about the duration rather than the allocation weight; we were at 4.5 years and now we are at 3.6 year as yields have come down. This duration exposure is the key differentiator for us because it doesn’t have to be in line with the index,” Somaia said. 

Doyle said: “We went into the crisis defensively positioned and are taking advantage of the re-pricing by buying Tier 1 credit”.

There were five varieties of the Schroder Real Return funds with different targets, the best-performing since the start of 2020 was the Real Return Single fund which had lost just 1.6%. 

The final step was to strategically allocate to defensive positions, cash or protection. 

Murphy said: “We have been dialling down our equity exposure and upping fixed income instead. We have also increased cash to take advantage of opportunities when we think the time is right.

“We have 30% cash, 40% in fixed income (mostly government bonds) then 7% to 8% in real assets. We haven’t put any large protection positions in place as most of our protection came from ratcheting down the equity exposure.”

Clark said the firm’s objective-based Inflation Plus range was utilising strategies such as foreign currency and tail risk hedges. 

“In the Inflation Plus range, we went into the crisis defensively positioned, we were underweight risk assets, had lots of cash and had defensive strategies in place such as foreign currency (USD, yen, euro and Swiss franc), had tail risk strategies and a gold position and these have done all well,” he said.

He said these moves, in particular, highlighted the benefits of an objective-based fund over a traditional balanced multi-asset fund.

“Our Inflation Plus funds are more aggressive, we were holding 10% to 20% cash which we couldn’t do in the accumulation funds, we wouldn’t be able to have the same level of foreign currency either,” Clark said.

There were three Inflation Plus funds, targeting inflation plus 3.5%, 4% and 5%, the best-performing was the Inflation Plus Conservative fund which had lost 2.5%.

However, due to the speed of the market moves and the volatility, managers still felt they would have done more if the circumstances had been different.

Somaia said the changes First Sentier had made were a “reasonably material move” in difficult circumstances but that the fund could have perhaps held more protection. By the time the difficulty of the situation became clear in late March though, he said, the implied volatility of put options was very high.  

“The price of insurance is dynamic so when your house is on fire, it’s too late to buy insurance,” Somaia said.

“We didn’t hold much fixed income,” said Clark. “If we had held more duration then we would have been happier but it was too expensive so we went for the currency, tail risk hedge and gold positions which have provided the cushion we needed.

“We have already crystallised gains from the tail risk hedge and taken profit on our gold positions and put a call option in instead. We are now looking for other defensive plays we can use. I don’t believe it is the time to be aggressive, there is too broad of a range of outcomes to be clear.”

ARE MULTI-ASSETS FUNDS A VIABLE OPTION?

Somaia said multi-asset funds could be an option for investors who wanted an alternative place to park their cash but highlighted investors should not expect it to achieve the same returns as equities.

“If you are after capital preservation then this type of fund can do that in volatile times. But the caveat is that if you are looking for equity-like returns then you won’t get that from multi-asset when the market is rallying hard,” Somaia said.

Doyle said: “Previously we have had very strong economies and supportive central banks and now you’ve had a shock and people are seeing how intertwined they were. They can’t sell illiquid assets which puts even more pressure on so multi-asset can help in this case as we are actively adjusting portfolios as opportunities come up and are operating with liquid assets to retain liquidity”.

Clark said the usefulness of these type of strategies as part of a retirement solution was under-appreciated by investors.

“If you are return-focused with time on your side then accumulation makes more sense but if you are risk-focused, either because you have a meaningful pool of money or less time and are worried about loss then it’s better to be in an objective-based one,” Clark said.

“As part of a retirement solution multi-asset plays an important role, you have to align it with your time horizon. For people who are conscious about drawdown and minimising losses, there is a real opportunity for this type of risk-conscious fund to play a role that is not appreciated.” 




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