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Multi-asset funds are becoming increasingly popular among investors seeking to manage risk and protect capital while also targeting growth. Increased volatility, slowing economic growth, geopolitical uncertainty and the worst returns from major asset classes last year since the 2008 financial crisis, have created a heightened awareness of risk and sparked fresh interest in multi-asset investing.
There are currently 1,027 UK domiciled multi-asset funds for sale to UK retail investors according to Morningstar1. Investment Association data shows that mixed-asset was the best-selling asset class in 2018 with £7.9 billion in net retail sales2 and a number of new funds have been launched this year.
The 2008 financial crisis was a catalyst for the growth of multi-asset funds, as it delivered a painful lesson on risk. On a less dramatic scale, the resurgence of volatility in 2018 (to more normal levels) was a fresh reminder of the issue of risk and another opportunity to consider multi-asset funds as a way to manage it.
The choice of funds has never been greater and advisers play a vital role in helping clients understand different multi-asset approaches and strategies.
A multi-asset fund is simply a fund that invests in a combination of asset classes – some invest in only a few, such as equities and bonds, while others invest in a wider range, encompassing areas such as property and commodities, and employing sophisticated asset allocation strategies.
The core appeal of multi-asset funds is diversification, and while the analogy of ‘not putting all your eggs in one basket’ is often used, it’s far from homespun wisdom. Nobel prize-winning economist Harry Markowitz published pioneering work on the impact of diversification on investment portfolios in 1952. He studied the effects of asset risk, return, correlation and diversification on probable portfolio investment returns and concluded that a diversified portfolio can provide investors with the benefits of reduced risk with no loss of returns.
For years the ‘rule of thumb’ was 60/40 for a core segment of investors (investing 60% in equities and 40% in bonds), the theory being that equities and bonds tend to be affected differently by key events and that an investment portfolio should contain assets whose returns are not perfectly correlated. However, asset allocation within multi-asset funds has moved on significantly from this simple 60/40 split. Many are now complex and it’s important to understand exactly how they are constructed and how their risk/return profile works. Expert asset allocation is at the heart of this, often supported by sophisticated risk modelling and performance profiling tools.
There has been debate recently over changes in the historic correlation between different asset classes, particularly as both bonds and equities declined simultaneously in 2018, limiting diversification benefits from being invested in both asset classes. Long-term studies show, however, that diverse asset classes (not just bonds and equities) rarely perform in identical ways year after year, as factors such as interest rates, inflation or world events tend to impact differently on different asset types. Data on returns from overseas equities, UK equities, UK government bonds, UK property, commodities and cash from 2002 to 2017 show wide variations on a year-by-year basis.
Last year was unusual, as most major asset classes reported negative total returns with the exception of UK gilts, cash and UK commercial property. According to Schroders, 2018 was only the third year since 1900 that returns from the S&P 500 share index and 10-year US Treasuries were negative in the same year3.
There has been debate recently over changes in the historic correlation between different asset classes.
There is no one-size-fits all approach to multi-asset investing and clients’ individual objectives and concerns, particularly regarding risk, must always be the paramount consideration. Common concerns do emerge, however: one fund manager said most investors want a fund with the volatility of bonds and the return of equities, which he joked is like looking for a unicorn.
Joking aside, there is nothing mythical about multi-asset investing. It is a serious undertaking that involves rigorous modelling and careful scrutiny of risk profile, asset mix and asset allocation strategy. The investment process, risk management, fund monitoring, and governance are as critical as the assets held in the portfolio – with the right ingredients in place, it has the potential to deliver a positive outcome for clients seeking to mitigate risk by diversifying the assets they hold.
Growing investor awareness of the potential benefits of multi-asset investing as a means of managing risk is fuelling both increased inflows into existing multi-asset funds and a flurry of multi-asset fund launches as investment institutions respond to increased demand.
Psychologists refer to a ‘recency effect’, whereby people remember the last thing that happened to them more acutely than events further back in time. In investing, events of greater psychological or emotional weight leave a more lasting mark. Last year’s poor returns across most major asset classes are likely to feature in this category as they marked a departure from an extended period of low volatility and steady returns.
Clients are more likely to seek advice in volatile times, providing an opportunity for advisers to remind them that knee-jerk reactions can potentially have an enduring negative impact on an investment portfolio. It also presents a fresh opportunity to discuss clients’ attitude to risk and to discuss the potential benefits of multi-asset investing’s disciplined approach to recognising, quantifying and mitigating different types of risk in order to manage risk and protect capital, as well as targeting long-term growth.
1 FT Adviser, 2018
2 Investment Association, February 2019
3 Schroders, January 2019