The old adage “do not put all your eggs in one basket”, inviting investors to keep portfolios well diversified, maintains its validity in modern times, but the way it is implemented is increasingly differing from past practices.
Traditional, balanced funds, which often represent the core of clients’ portfolios, are being replaced by more flexible solutions investing in a variety of asset classes. “Asset allocation funds have been around for many years, but they were mainly relative return products, which did not deliver the results clients expected,” says Stefan Angele, head of investment management at Swiss & Global.
“The focus is now more on goal oriented investment multi-asset solutions, which have a total return approach,” he says.
Fund houses managing these solutions do not follow a benchmark, but are given a “risk budget” to spend in the most efficient way, within the asset allocation framework, and have a more opportunistic, dynamic and flexible approach to asset allocation.
Futures, derivatives or exchange traded funds (ETFs) can be employed for short-term opportunistic views, while actively managed funds are used to invest in more secular trends, in fund of funds solutions, he explains. Good skills in risk management are also needed.
At Wegelin, Switzerland’s oldest bank, the concept of multi-asset investing is combined with a risk-weighted, as opposed to a capital-weighted approach. It is the bank’s belief that traditional balanced portfolios fail to achieve risk diversification, because riskier asset classes can dominate the total portfolio risk, says Dr Magne Orgland, managing partner and head of asset management research & portfolio management at Wegelin & Co.
In November 2009, the bank launched its Global Diversification Fund, which employs a quantitative approach aimed at ensuring each of the four asset classes used in the fund – equities, bonds, commodities and short-term government bonds – contribute equally, on a daily basis, to the total portfolio risk.
Indeed, optimum portfolio weightings are calculated on the basis of various risk indicators and adjusted daily. The bank claims this frequent rebalancing does not increase costs, as the fund invests in passive indices, ie in futures contracts on liquid indices, to ensure low transaction costs.
“The future of multi-asset investing is this equalised risk approach. The target is to provide an attractive return with much lower volatility,” insists Dr Orgland.
Particularly in bear markets, when equities are volatile, the fund is much more stable than a classical balanced fund, he claims.
The tail risk management engine in the fund identifies high risk in the market and systematically reduces exposure to it. Year to date, the fund has reduced exposure to equities down to zero twice and it has returned 8.5 per cent, he says.
“In uncertain times, it may be even more important that you have consistent decision making and don’t deviate from the rules you have set in the process,” says Dr Orgland. “What has become more important is transparency, because investors do not want to invest in black-boxes. That is why the quantitative approach should not be overly complicated and always explainable,” he says.
However, in a bull market, when equities are strong, the fund will perform less well than an equity portfolio, where the risk comes only from equities. As it is a long-only investment, it does not take short positions and could potentially produce negative returns.
Wegelin’s private bank selects third-party single funds for clients, using many indexed funds and ETFs, but does not buy multi-asset funds from external providers.
BATTLE FOR PRODUCT TERRITORY
Although asset managers claim multi-asset funds are a valuable building block for the core part of high net worth individuals’ portfolios, private banks tend to see asset allocation as their core competence and are reluctant for their clients to invest in this kind of strategy. “We run multi-asset portfolios, that’s our core skill set, and we don’t buy multi-asset funds,” confirms Robin Hubbard, head of investment management at UBS Wealth Management in London. “We construct the asset allocation and populate it with different instruments, primarily funds, but these are almost without exception single asset funds.”
Private bankers are often criticised for their way of managing investors’ portfolios, often seen as too static to adapt asset allocations to changing market conditions in a timely manner.
“The key issue is that implementation systems are needed to be able to execute across multiple clients’ portfolios simultaneously,” explains Mr Hubbard. Because of its size and scale UBS has invested significantly in technology, to be able to adjust to market conditions quickly.
However, there are a number of constraints. Clients do not necessarily like to see a high level of activity in their portfolios, he says, and as activity becomes very transparent when managing portfolios in that way, clients’ preferences have to be taken into account.
