Multi-Asset Strategies
April 2016
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bfinance
Multi-Asset
Strategies
April 2016
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Table of Contents
04 Introduction
04 Balanced Strategies
05 Diversified Growth Strategies
06 Absolute Return Strategies
‘Advanced’ Diversified Growth Fund
Diversified Alternatives
Alternative Risk Premia / Alternative Beta
07 Key Selection Criteria
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Introduction
Multi-asset strategies are a diverse group of investment approaches which vary widely in
their permitted investment universe, investment style and risk/return objectives. The earliest
versions were balanced funds (some funds that are still in existence date back to the
1920s), which allocated relatively statically to standard liquid assets, predominantly
developed market equities and high quality bonds. As the institutional investment landscape
has changed to encompass a wider range of asset classes, sub-asset classes and
investment strategies, so too has the multi-asset space with a move towards more total
return or absolute return objectives and generally a greater focus on diversifying away from
the heavy equity risk present in balanced strategies.
Over time, strategies have generally increased in their level of sophistication and the
manager landscape now ranges from those more traditional balanced products, though
more diversified but still largely long-only approaches, to true absolute return strategies
which may have more in common with hedge funds than the balanced approaches. The
level of complexity, risk/return objectives and many other factors in the multi-asset space
vary widely, so careful mandate definition and manager selection is key. What essentially
unites all these strategies is the ability to invest across a range of asset classes and
instruments with the fund manager varying the allocation to each according to economic
conditions, performance/risk expectations or other factors.
Though the heterogeneity of approaches makes sharp delineations of the manager universe
challenging, we elaborate on three broad categories below. These categories should not
necessarily be seen as mutually exclusive, nor jointly exhaustive, of the multi-asset space,
but provide some thoughts on the landscape of different approaches available and the
different roles that they can play in the portfolio of an institutional investor.
Balanced Strategies – long-only equity and fixed income
The longest-running and simplest multi-asset strategies can be categorised as traditional
and balanced; long-only equity and bond portfolios with a relatively static strategic asset
allocation. To a large extent, such strategies mirrored the institutional investor’s typical fixed
income / equity portfolios before the development of some of the more exotic or niche asset
classes or indeed before hedge funds and alternative strategies were offered as an
institutional asset class.
Within such funds, tactical changes to the asset allocation between equity and bonds is a
somewhat more marginal driver of value given the typically tight permitted limits around a
strategic mix (e.g. 50% equity & 50% bonds, +/- 5-10% on a tactical basis). As such, risk
and return characteristics can be largely attributed to directional market exposure (market
beta), with the equity allocation typically dominating the level of risk.
Benchmarks / Performance Attribution
> Comparatively easy to benchmark using a relevant strategic blend (such as 60/40
or 50/50 equity/bond mix)
> With such closely determined asset class limits, performance attribution to asset
allocation decisions (strategic benchmark vs. a manager’s timing through being
overweight equity or bonds) and security selection (added value within each asset
class) can be done with relative simplicity.
> Due to active decisions being more marginal drivers of return, performance
dispersion among managers with similar strategic benchmarks is relatively low.
Role in the Portfolio
For investors with a benchmarked strategy, traditional balanced funds can provide a useful
way of outsourcing tactical asset allocation decisions and the chance to exploit a manager’s
skill in timing allocations across asset classes. They are also appropriate for those investors
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who have a ‘simplicity first’ approach, seeking to harvest traditional risk premia in a cost
effective manner as the primary objective with a smaller role for added value from manager
skill.
We would note that in general, interest in truly traditional balanced approaches has waned
as investors look for more diversified exposures in their multi-asset allocations and/or take
tactical decision making in-house and select single asset class specialists for standard
markets. However within this category, dedicated emerging markets focused approaches
have been of interest to our clients.
Diversified Growth Strategies – increasingly diversified
but still essentially long risk assets
As markets have developed and an increasing number of strategies and asset classes have
become available, institutional portfolios have evolved and so too has the multi-asset fund
manager space. Diversified Growth strategies, whilst still predominantly long-only, make use
of the increasing number of asset classes available investing in both traditional (fixed
income, equity) and alternative spaces (real estate, infrastructure, commodities, private
equity, credit, hedge funds) as well as being much more active in their asset allocation
decisions. In particular many strategies will have wide permitted ranges of exposures to the
various asset classes that are used (e.g. equity exposure 0-70%) as well as greater freedom
in the methods of implementation. For example in taking equity exposure, managers may
use index futures or ETFs to gain efficient and broad access (although even here different
styles may be used such as Value-Growth, Size etc), or for more nuanced exposures active
strategies or custom baskets either managed internally or externally may be selected.
The inclusion of alternative asset classes and strategies (typically in moderate amounts of
c.10-30%) is one defining feature relative to balanced approaches. However even within
traditional asset classes there has been a widening of the investment universe. Within fixed
income areas of credit such as high yield, emerging market debt and structured credit are
commonly used, along with the use of currency as an alpha driver. The same can be said of
equities, with the greater use of emerging market allocations in particular relative to the
traditional balanced approach.
This growing complexity and wider investment universe provides managers with an
increasing number of ‘levers to pull’ and consequently a manager’s level of activity and skill
is central to adding value and driving performance. Though still fundamentally long risk
assets, such strategies will vary in beta exposure both between managers and across time.
Rather than simply taking a view on the level of growth versus defensive assets held and
tilting portfolio weights within a fairly narrow range, managers are able to vary asset
allocation more widely and use a wider variety of asset classes ultimately with the goal of
providing a smoother return profile than that experienced in balanced approaches, which as
mentioned above, typically have their risk profile dominated by the level of equity exposure.
Benchmarks / Performance Attribution
> Inherently harder to benchmark given the increased number of tools available to
managers in order to drive return.
> A departure from clear strategic asset class-based benchmarks to more absolute /
total return targets is common; e.g. cash rates or inflation index + a margin (3-6%
generally) depending on the level of risk. Qualitative performance and risk targets
are common, e.g. equity-like returns with less than half the volatility of equities over
3-5 year periods.
> Dispersion of returns between managers can be high, particularly around ‘turning
points’ in the performance of risk assets.
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Role in the Portfolio
Diversified Growth funds are generally used as a (partial) replacement for, or diversifier to,
an equity allocation within the growth portfolio of institutional investors. We have also seen
certain institutional investors using these strategies for their whole portfolio, essentially
outsourcing all asset allocation decisions to the chosen manager(s) – this is typically
appropriate for smaller pools of capital where internal resources are more limited.
Diversified Growth funds can allow such investors to gain multi-asset exposure in one
solution rather than overseeing a multi-manager portfolio of asset class specialists.
Absolute Return Strategies – furthering diversification
This is in itself a broad category with the unifying factor generally being an increasing
diversification of investment styles away from being long risk assets.
‘Advanced’ Diversified Growth Funds
A group of products have been developed that are commonly classified as Diversified
Growth Funds, but depart from the definition used above in making less use of long market
exposures to drive returns. In particular they make much more extensive use of the ability to
take short positions (at both market and security levels) either as part of directional
(negative) views or as part of a relative value trade.
Unlike traditional balanced and diversified growth approaches which have inherent long
directional exposure to risk assets, these strategies generally seek to generate returns
much less correlated to broader markets.
Managers offering such products are much more active and strategies far more complex
including the use of notional leverage (through derivatives). Such strategies are more akin
to global macro hedge funds, though typically provide increased diversification and liquidity.
Diversified Alternatives
There are also multi-asset products that focus specifically on the alternatives space. Such
portfolios may include a mix of hedge funds, private equity/debt, real estate equity debt,
niche credit, infrastructure, commodities, timber/farmland, catastrophe bonds etc. As a
result these can be significantly less liquid strategies.
Diversified alternative strategies can be seen as offering a one-stop shop for a true
alternatives allocation without the investor having to manage for example, a private markets
and a hedge fund program separately. As such they can in particular be attractive to smaller
investors who lack the resources to take a more granular approach. For larger investors,
managers of such strategies are also able to provide tailored portfolios with the explicit aim
of complementing or diversifying exposures elsewhere.
Alternative Risk Premia / Alternative Beta
Alternative risk premia (alternative beta) strategies are a somewhat newer variety of multiasset strategies (please see ‘Alternative Beta’ - Chris Stevens, Senior Associate, bfinance).
Essentially such approaches are rules-based (systematic) and make use of non-traditional
investment techniques (shorting, leverage) to isolate attractive risk premia beyond those
available via long-only investments in traditional asset classes. In particular, they seek to
capture the various ‘style premia’ (value, carry, momentum etc) in a market neutral manner.
For example, they may seek to capture the value premia in equities by being long value
stocks and short growth stocks such that beta neutrality is maintained, or they may
implement FX carry trades by being long high carry currencies, funded by short positions in
low carry currencies. Certain managers also seek bottom up replication of certain hedge
fund trading styles, for example merger arbitrage.
Alternative beta strategies can be an efficient way of accessing truly diversifying return
streams that are typically characteristic of hedge fund allocations for those investors that, for
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legal or regulatory reasons, are not currently able to access these return streams, or for
investors that simply do not wish to take the illiquidity, high fees and lack of transparency
that can be part of hedge fund investing.
Benchmarks / Performance Attribution
> Absolute return products are typically highly outcome-oriented, work towards a
stated outcome and target an objective such as cash +4-5% over a 3-5 year period.
Alternative beta strategies are typically managed to a target level of risk, frequently
with an explicit target of beta neutrality.
> Performance attribution is inherently more challenging. Emphasis should be
placed on the level of transparency the fund manager provides in their underlying
holdings / positioning.
Role in the Portfolio
Absolute return multi-asset strategies are capable of playing a variety of roles, but
principally are also used as a diversifier to equity risk. In explicitly targeting returns that are
less correlated to risk assets they can bring diversification to the wider portfolio in particular
by providing exposure to niche asset classes, different risk premia and / or investment
styles. In many cases they can be used alongside, or in place of, other alternative
investments such as standalone hedge fund allocations.
Key Selection Criteria
Given the heterogeneity of potential approaches, it is often difficult to make direct relative
comparisons of either quantitative or qualitative factors across a peer group particularly for
the Diversified Growth or Absolute Return strategies. A tailored approach is required,
assessing each strategy on its merits and issues individually. The bfinance team have
experience in assessing all of the strategies described above.
The team size and background of key people should be complementary to the strategy
proposed. For example, strategies investing globally in individual stocks, bonds,
commodities etc based on fundamental analysis will need greater depth of team resources
than more systematic strategies such as risk parity or alternative beta where quantitative
research and efficient implementation experience among a typically smaller team will be
more important.
It is also important to understand a managers’ capability through the use of wider resources
within the organisation often not reflected in headline team numbers for the strategy. In
particular, many mangers will merge top-down and bottom-up approaches by having a small
asset allocation team that can bring greater depth and experience to the strategy by
allocating slices of the portfolio to other teams / individuals within the firm, or to carefully
selected external managers.
Performance analysis should incorporate not just annualized returns and volatility, but also
the higher moments of the distribution. Performance during challenging markets for growth
assets (2008, 2011) should be scrutinized and understood based on attribution analysis.
Attribution analysis detailing the contributions to performance of the strategic asset
allocation, tactical decisions as well as position selection should also be analyzed where
relevant.
Multi-asset strategies will generally have a wide range of risk factors that they can take
exposure to on a dynamic basis so the proprietary bfinance risk model can be an
appropriate tool for manager analysis. This can also enable an examination of the potential
diversification benefits to an investor’s total portfolio beyond a simple historical returnsbased analysis.
Operational due diligence may also be appropriate for the more complex strategies in this
space.
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For systematic strategies in particular, an ongoing research program into the models used
to determine allocations is seen as a positive. Significant changes to the process affects the
reliability of track records however.
Capacity and liquidity constraints should also be examined where relevant. Liquidity levels
depend heavily on the underlying holdings. Strategies investing predominantly in futures
and liquid cash markets will be able to provide daily or weekly liquidity and many strategies
are available in UCITS format. To an extent, this is very much a structural feature; for
managers to be able to take an active approach to asset allocation and capture changes in
the environment liquidity is needed to efficiently execute the strategy. Within the Diversified
Alternatives allocation, longer liquidity can be appropriate if private markets or the less liquid
hedge fund strategies are utilised.
Finally, as might be expected, there are a wide range of fee levels for the various
approaches described above. In general, fees increase with complexity.
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Our Diversifying Strategies Team supports clients with portfolio strategy and design,
risk advice and manager search and selection.
bfinance has conducted over 750 bespoke manager search and selection exercises
for over 250 clients in 28 countries around with world advising on over $150 billion
across all asset classes.
> Specialist asset class units with extensive practical experience
> Flexible ongoing or project-based partnership
> Direct co-operation with senior staff comprising industry practitioners
> Our approach is bespoke and fully customised
> Exhaustive coverage of the manager universe, no ‘buy-lists’
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