1. Understanding the origins and drivers of multi-asset investing
2. Identifying the key sources of risk and return in the investment process
3. The pros and cons of comparing multi-asset performance against benchmarks and peer groups
Tutors on the panel are:
David Coombs, Head of Multi-Manager Investments, Rathbone Unit Trust Management
Tom Caddick, Head of Global Multi-Asset Solutions, Santander Asset Management
Frank Potaczek, Head of Insight and Consulting (Fund Management), Defaqto
PRESENTER: Hello and welcome to this Akademia workshop on outsourcing. In previous programmes in the series, we’ve looked at consumer attitudes to risk, the different outsourcing options available and the benefits of outsourcing. And you can click on the links in front of you that you can see there now to go back over any of those workshops.
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In previous programmes, over the last few months, we’ve looked at attitudes to risk, particularly among clients, the benefits of outsourcing and the different options that are available. Well in this final programme we look at the investment engine behind it all. How do you define the investment philosophy; what’s a reasonable time period to judge the success or otherwise of the strategy; and now that every provider calls itself a multi-asset player, what exactly do they mean by that?
Well, to discuss these and other related topics, I’m joined now by a trio of experts. They are David Coombs, Head of Multi-Manager investments at Rathbone Unit Trust Management; Frank Potaczek, Head of Insight and Consulting for Fund Management at Defaqto; and Tom Caddick, Head of Global Multi-Asset Solutions at Santander Asset Management.
Well, David Coombs, I mentioned there in the introduction multi-asset, but where’s it come from exactly? Is it just multi-manager with a few bits and bobs added onto the end?
DAVID COOMBS: No, I don’t think so. Actually, I think multi-asset frankly has been going on for 50/60 years. It used to be called balanced probably in its early days and just bonds versus equities. Multi-managers are something completely different in my opinion; it’s just manager selection. Multi-asset can be multi-manager, it can be single manager, it can be passive, it can be active. My definition of multi-asset is just trying to generate a return for a certain level of risk and using a number of different asset classes or investment strategies which are uncorrelated to try and produce that kind of return.
PRESENTER: Well taking that on then, Frank, would you go along with that, really it’s institutional rather than retail?
FRANK POTACZEK: Well, it certainly was institutional, and I think one of the things that we’re seeing certainly as investment strategies become a little bit more sophisticated that we’re taking an awful lot of what the institutional space has done and incorporate it within the retail space. Certainly what we’re seeing within the retail multi-asset space is a lot of incorporation of new investment strategies that possibly weren’t around let’s say 10, 15, 20 years ago in terms of the balanced; it was all very sort of plain vanilla. But certainly post-2007/2008 there’s been a lot more attention to the various investment tools being incorporated within the multi-asset space.
PRESENTER: Tom Caddick, would you go along with that; you’ve moved from, if you like, a retail to a more institutional environment over the last few years as a fund manager?
TOM CADDICK: For me I sort of think of it more in terms of, those two areas, the lines have blurred to a certain extent. I mean I’d say that certainly the retail space has upped its game; taking on more sophisticated tools, more sophisticated approaches and blurred the lines between retail and institutional, to the point where it almost becomes irrelevant talking about those two different areas.
PRESENTER: But given that, David, what are some of the things that perhaps in the last five or six years you’ve taken on board that maybe you didn’t do in the mid-1990s?
DAVID COOMBS: I don’t know about taking on board, it’s just there are more opportunities. I mean just to take the time since 2008, when a lot of banks have withdrawn capital from prop desks, you’re seeing many more strategies being securitised and available to investment managers such as myself. Whether it’s leasing or collateralised loan obligations, you know, these tools were just not open to us 10, 15 years ago. Hedge funds have been round quite a long time; alternative strategies, that’s not new; but being able to invest directly and more specifically in the specialist areas is pretty new.
PRESENTER: But what gives you the confidence to say get involved in aircraft leasing for the first time ever?
DAVID COOMBS: Not the best example, I’ve not bought aircraft leasing, but I think that when you analyse an investment, whether it’s an asset class or investment strategy, risk is still fundamentally the same. Whether it’s volatility, drawdown, credit or equity risk or financial risk, you can use similar techniques across most of these strategies. Ultimately, it’s the same; it’s a withdrawal of capital from any of those markets and liquidity. And whether you’re looking at a high yield bond or you’re looking at a strategy that involves an aircraft leasing, fundamentally the risks are the same; albeit, they’re probably uncorrelated.
PRESENTER: Tom, would you go along with that, or is there a certain amount of extra due diligence you do before buying a certain instrument for the first time?
TOM CADDICK: No, I mean I think in principle I go along with that. I mean the basics are the same. There’s always going to be increased levels of due diligence, I think. I mean as most people will know I mean our preferred choice is to, you know, if we have a preferred route of asset type to go down is to identify the very best managers that can access that and the best skills to go down there. And I’d always recommend caution when approaching something for the first time, afresh. But yeah in principle the risks are the same.
PRESENTER: Well, Frank, at Defaqto obviously you’re analysing multi-asset providers the whole time, how do you cope with this explosion in the number of new instruments that have come out there in the last few years? How do you analyse them and work out if people are any good at using them or not?
FRANK POTACZEK: Well we don’t look at the qualitative side of things, it’s all about the quant; it’s what are the results of how they actually use them. Just really sort of taking on the fact from what we’re using in terms of the investment tools, it’s all about making sure that the guys actually know what tools they’re using and how to actually put them into the portfolio. The one thing that we’ve seen over the past some number of years is guys looking to incorporate new things and not quite getting it right. Their risk-adjusted returns haven’t really sort of, hasn’t shown to be as good as it should be. So I would actually look at those guys who’ve got some experience in buying other funds and actually seeing how they incorporate that into their portfolios.
PRESENTER: So your measure of funds looks at outcomes, so.
FRANK POTACZEK: Absolutely.
PRESENTER: So how can you distinguish between what’s luck and what’s judgement?
FRANK POTACZEK: Well, that’s the thing; it’s about consistency isn’t it? Because you can be lucky up to a certain point, is the investment decision that the manager’s taken by default or by design? And that’s where a qualitative overlay sometimes helps to actually differentiate between the two. But at the end of the day it makes no difference what the message, what the story is that the investment manager is telling you, as long as the results are there there’s a consistency of performance. They’re hitting the mark, they’re hitting the investment mandate that they’ve promised to give, then that’s a measure of success.
PRESENTER: Well, Tom, you’re running multi-asset money in a group that probably traditionally is better known for running single asset funds. Is there a single culture that can encompass all of it or are you a little bit out on a limb?
TOM CADDICK: No, I mean if anything I’d say the opposite for Santander Asset Management, and we’ve got a history that goes back 20 years or so of multi-asset style of investing. I mean for me the big difference between multi-asset and single asset, and we were starting to talk about it earlier when we talked about multi-manager. For me, multi-manager is a delivery choice. It’s a delivery mechanism. Just like direct to market or direct access to the market might be a delivery choice. So multi-asset for me is more about solution provision, so providing investment solutions to the end customer. So as an investor their one and only investment may well be one multi-asset portfolio, whereas typically single asset I think of as building blocks in its simplest form.
PRESENTER: Okay, and when you look at that then, David, and you’ve talked about the sort of perhaps more institutional background that multi-asset has come from originally, does that mean there’s sort of certain investment houses that are more naturally likely to be good producers of multi-asset than others?
DAVID COOMBS: It’s difficult to say. I mean certainly multi-asset was well ensconced within the life companies. For example, we’ve seen a lot of products with Standard Life and Aviva who’ve brought products out of their life companies and brought them to the retail market. But there are examples of other asset managers who had expertise in various asset classes, equities and fixed income who brought them together; they just might not have been so high profile in the retail market. Even companies like Barings and Schroders will have had that expertise over a long period of time, but mainly in the institutional market, not in the fund market.
PRESENTER: Frank, moving this on, multi-asset, not all these funds are run the same way, what are the key distinctions to make?
FRANK POTACZEK: Well I think really looking at is there a defined investment mandate first and foremost? If an adviser’s looking to judge which one of these multi-asset portfolios is suitable for their clients and their segmented client base, then working out what the investment manager’s doing and whether they stick to is very very important. There are a whole host of different multi-assets out there, different types of investment tools that are used, but again it’s about the consistency of performance in their chosen investment mandate.
So for example if there’s an investment mandate for a total return, are they producing that total return on a consistent basis. If one looks at, for example, the targeted absolute return sector, the IMA or the Investment Association’s new sector, then it basically says there’s a bout of volatility, it’s about one year volatility, and yet there are some funds who are in that sector that don’t actually do that. So if you promise to give something, a certain return or a certain investment mandate, then we’re looking at that consistency of performance.
PRESENTER: But the key distinction you make, would you make a key distinction between those funds that are targeting a level of risk and those funds that are trying to target a level of return?
FRANK POTACZEK: Well risk and return are part of the same coin. Obviously if there’s a lot more in terms of risk then is risk about volatility. And if it’s about volatility making sure that there is a certain level of volatility that’s being given on a consistent basis. There are some funds that are unconstrained that go out there and actually look to provide a total return within an asset allocation perspective, but those guys that are looking at risk from volatility, basically measure themselves and make sure that they can’t be any above or below that volatility banding.
PRESENTER: And you mentioned asset allocation there, when you talk to a lot of the multi-asset community they’ll say majority of returns come from asset allocation, ultimately, do you go along with that?
FRANK POTACZEK: If you believe in modern portfolio theory, absolutely, and the vast majority of people do. There’s been a lot of question about modern portfolio theory after 2007/2008, where a diversified portfolio might well have actually gone down and all assets correlated together and actually went down. I think it’s been proven over the past 60 years that in the vast majority of time that modern portfolio theory actually works and asset allocation is a major driver. However, if you’re looking at producing an income strategy, then perhaps the asset allocation that you use will be different from an income perspective than from a total return perspective.
PRESENTER: David, do you go along with asset allocation is really the core generator of returns and risk in these portfolios?
DAVID COOMBS: I think it depends on the time horizon actually. If you invest in a long-term multi-asset strategy, say ten years plus, frankly asset allocation will be less important, because you’ll mostly be invested in risk assets and then the bottom up is going to be the driver of the marginal return, i.e. for the fee that you’re paying. For shorter term and lower risk strategies, then yes, asset allocation is key. Because take for example last year if you’d had more gilts than equities you’d have a very good risk-adjusted return; if you had more equities than gilts you’ve had quite a poor risk-adjusted return. So it really depends on time horizon, it depends on your appetite for risk, and those who invested for longer term should have a higher appetite for risk, and then frankly you’re going to be most invested in equities. So asset allocation becomes less of a driver of the extra return you expect for the fee that you’re going to pay.
PRESENTER: Interesting, I mean as multi-asset providers you at Rathbones, many people do the same, will run a family of funds with different risk rates, which ones do you feel most comfortable running, the longer term or the shorter term ones?
DAVID COOMBS: It doesn’t really make any difference to be quite honest with you. From my perspective, I run three funds and I run them in a very different way. The one with a longer term time horizon means I’m making less active decisions on a day-by-day basis, because I have a longer time threshold to allow the themes to work through. For the lower risk fund, then turnover tends to be higher, because I’m constantly taking profits or reinvesting the capital. And so it’s just different. It’s not better or most comfortable; it’s just being aware that you have different risk budgets and manage the money accordingly.
PRESENTER: And, Tom, how long-term can you be in a world that increasingly looks at short-term performance?
TOM CADDICK: Yes. I mean I think this is a great challenge for our industry, generally, because we all talk about long-term time horizons being of paramount importance. We encourage our clients to come in with a long-term time horizon, and that time horizon is anything up to and beyond a business cycle, three, five; most of us would encourage a longer time horizon. But in reality we then in the media, in the way in which we talk, we talk about much shorter term measures. I mean you’d be lucky if at the yearend you’re talking about year-to-date; typically you’ll be talking quarter-on-quarter.
I firmly believe in the long-term requirements for an investor, but we have to acknowledge that people will want to talk about the shorter term. It’s not helped by the media. Particularly things like the nationals, where you see on the BBC news, they start talking about whether now’s the time to sell. And they start talking about whether now’s the time to sell oil or buy oil, it’s pushing this issue further and further, but that’s the world that we live in. So I’d love to say that everyone should always always focus on the long term, they should, but we’ve got to accept that the shorter term comes in.
FRANK POTACZEK: I mean Tom makes a very interesting point, you know, lot of advisers traditionally have actually been looking at different performances in terms of quartiles, be it the first quartile or fourth quartile. With the vast majority of advisers, and I think the figure is 73% of advisers now are using cash flow modelling. The idea that advisers are building a holistic financial plan that sort of says well my client needs let’s say 4% compound, 5% compound over the next 20 years, how do you actually go from telling the clients your assets need to grow by 5% compound for the next 20 years to picking a first quartile or a fourth quartile fund? So it is very much sort of targeting the outcome, what is the investment strategy that multi-asset fund is giving you?
The other thing of course is tying it back to risk, do you want that journey to be shorter and bumpier, or do you want it to be smoother and then longer, and as David said timescale certainly plays a part in that.
DAVID COOMBS: I think there’s room for optimism here, because I think with the work the FCA has been focussing on more recently on suitability and emphasising due diligence on switching and making switching harder, I think advisers are taking a longer term view of investment solutions. Coupled with the fact, in my experience, and maybe this is because I run risk-targeted funds, but the advisers that we’re talking to seem to be much more focussed on risk and attitude to risk and capacity for loss than necessarily on chasing shorter term returns. Obviously returns are still important and there’s definitely short termism particularly in the single sector space, absolutely. I can’t see that’s particularly changed, but I do sense at last that with multi-asset there is a slightly longer term view. Maybe that’s blind optimism, but that seems to be the trend I’ve noticed in the last sort of 18 months or so.
PRESENTER: There are two bits that I want to pick up. First of all, when you were talking about if you were able to take that longer term view it’s easier to back an active manager in the long term, have you got examples of a couple of managers that you - I wouldn’t say tuck away and then ignore but you can sort of hold for the longer term?
DAVID COOMBS: Right, let’s look at the US, for example, everyone says the US is very hard to identify managers who outperform, and certainly if you look at any IMA sector with any rolling three year period the stats would back that up, there’s a lack of consistency of managers continually outperforming. We’ve spent a lot of time looking at this. And in our view if you want to pick a US manager you’ve probably got to look at five, seven and even longer number of years to generate alpha, and that’s telling you, you need to be more patient in more perfect markets. I mean I take the ClearBridge US Aggressive Fund, for example, which is a Legg Mason US fund, there’ll be times, and it could be three years, well that fund will underperform. You’ve got to give those managers the time to generate that alpha; otherwise, you’re just constantly selling a fund when it’s low and buy another fund when its valuation is high.
So I think the US is a great example of where you’ve just got to be more patient. And of course patience is risk. If you’re sitting in front of a client every year saying well he’s underperformed again but I’m convinced he’s going to be okay, that’s a big decision, quite a hard decision for an adviser to take, but ultimately I’m absolutely certain that it’s the right decision to take.
TOM CADDICK: Yes, I mean I’d agree with that point actually, because I think the best mitigator of risk within a portfolio is, typically, time. Going back to some of the things we were saying before about asset allocation and being the key driver and in Frank’s point on MPT, you know, if we believe in modern portfolio theory, if we believe in the mix of assets and the different asset classes broadly speaking are uncorrelated over time will produce a different risk return mix, how do you compensate for increased volatility? Well, ultimately, what you’re saying is, what’s the real impact of volatility on a portfolio? It’s the risk of loss, potentially. But over time the expectation that you’ll be compensated for that loss through return. So the best way of mitigating your risk within your portfolio, outside of diversification and mixing your portfolio, is to give it time.
PRESENTER: Now, David was saying earlier his portfolios he’s running are risk targeted, is that the case for yourselves at Santander?
TOM CADDICK: Yes.
PRESENTER: Right, and I don’t know if you have one that does this, but say you’re aiming at 5%, you’ve got a set risk target, what do you as the year goes on if you’re undershooting that or overshooting that; does that affect the way that you then run the money? It’s sort of got to September and you think either I’ve got some budget to use up here - I don’t want to be so flippant about it but.
TOM CADDICK: And the answer is absolutely not. So I mean it very much depends on the timeline that you use to measure the risks that are inherent within your portfolio. We take a longer term view on volatility within the portfolio. On the basis that short-term triggers will lead to higher turnover within the portfolio and lead you to effectively chase your tail within the portfolio to try and meet that risk target. So our view is that the risk target and the target for that volatility should be in line with our investment horizon and beyond.
PRESENTER: And, Frank, just on the other side you were saying there with cash fund modelling advisers often sort of think I’ve got a client here who we’d like to sort of compound at 5% a year or 4 or 7% or whatever, again what pressures can that put on advisers if there’s a year where they miss the numbers or they outperform massively and maybe think this is a bit easier than we thought, maybe they should be a 7% client not a 5%?
FRANK POTACZEK: Absolutely, and I think it’s all about the long-term plan. To be able to actually sit down with a client and map out the potential growth expected over the next 20 years is something that we haven’t done in the past to any great degree. But the idea is that at the annual review there’s a meaningful direction of travel that the adviser can actually talk with the client. So if they do overshoot the obvious thing is do we actually dial down the risk for that particular client or do we actually sort of go with it? And I think when you establish tramlines, an upper tramline and a lower tramline, so you can see a level of volatility for a particular investment.
So overshooting/undershooting is what happens to investments. They don’t go up in a straight line, they don’t go down in a straight line, it’s not a straight line return year in year out, and yet that’s what we’re saying in terms of expected returns. So if they do overshoot, if they overshoot within accepted boundaries, then that’s fine, that’s what we’re expecting; if they undershoot in the same boundary, that’s what we’re expecting. But if they go beyond that then that’s a time that you sit down with your client and you say okay fine you’re undershooting that particular investment, does that mean we have to take more risk to get you back to where you are or do we actually have to say okay fine the money that you’re looking to get at the end of this term could actually be lower?
So it prompts a discussion between the advisers and the client, and it’s not saying this will happen, but it’s what do you want to happen, are you willing to take more risk or less risk, and it prompts the adviser to actually have that meeting.
PRESENTER: And in some ways perhaps, David, is that very similar to if I say yourself if you’re looking at an actively managed fund then it behaves very differently from how you expect, that’s the time to go back and reassess what’s going on?
DAVID COOMBS: Yes, we target relative volatility rather than absolute, because we feel we can only invest in the market environment at the time that we’re investing. I mean basically if the fund’s overshooting in terms of return but we’re comfortable with the risk on a forward looking basis then we’ll overshoot. The key though then is if you do that is to let investors know that you’ve overshot, because what you don’t want are new investors coming in because they think that return is replicable, because sometimes it just isn’t. An example of this would be 2009 through to 2010, a lot of low risk funds had double-digit returns, which are not, you can’t repeat those, and you’ve got to be very careful that you explain to investors that yes we had a fantastic year but going forwards for that level of risk we don’t anticipate that return.
PRESENTER: And that was because the government’s effectively propped up the bond markets and you were heavily into…
DAVID COOMBS: Absolutely right. I mean you could argue it’s still going on given what’s happened with gilt yields last year. But I would couch even from here saying that looking over the last five years at multi-asset funds you need to be very careful in the analysis, because when you’ve got that level of buying going on to government and actually corporate bond markets you have had a free ride. You’ve had extra normal returns for units of risk that you’ve employed. I think going forwards from here where yields are today we should probably see a very different return profile the next five years.
PRESENTER: Well, given that a lot of the data that we use is historic, does this mean it’s actually skewing what the risk reward characteristics of gilts are for example?
DAVID COOMBS: Very much so. I think expectations are too high. I mean I run a lower risk fund that targets cash plus 2%, and it’s been doing 5 or 6% for the last couple of years; that’s a real return of something like 3 to 4%. That’s an equity type return taking 5% volatility. Now if I’m sat here in five years’ time and my fund is still 5% volatility and achieving a real return of 4% I should probably be knighted. I mean I don’t think it’s possible. But people have got used to that and people are saying well should you change your investment objective, because cash plus 2% is too easy? And that’s a very scary question, actually, because risk hasn’t changed, you know, it’s just we’ve been over-returning in lower risk mandates.
PRESENTER: But taking that on does that mean perhaps to balance it out at some point in the future lower risk mandates will be underperforming just to let things out and again as a manager how do you explain that?
TOM CADDICK: I think absolutely that’s the potential there. I mean I think Frank’s point was a great one, which is talking about the sort of tramline approach, and if you can imagine that the mix of potential outcomes with a given risk return type strategy over time that can give the investor, can give the adviser the feel for what to expect from a particular strategy. Now the problem that we’ve had, if you take that tramline strategy, an idea further, you would imagine those tramlines to be tighter the lower the risk and wider the higher the risk. So in other words the range of outcomes will increase in terms of potential returns, those range of returns will increase the more risk you take on.
The problem is we’re coming out of the back of a period in which we’ve effectively been paid for risk. We’ve been paid for risk, and in some cases we’ve been paid for not taking risk as well. So we’ve had this sort of skewed effect. But outside of that skewed effect really it’s been a good time to invest in equities, generally, the last sort of five years or so has been a good period. And now is a great time to have those discussions with clients to remind them that this is not, you know, don’t expect these compound returns, it will not continue to be like that. That’s not to say that Armageddon’s round the corner, but just to be sensible in the way in which we approach risk.
DAVID COOMBS: And the mathematics are against you, in yields as low as 1.6% on UK gilts and 0.5% on German bunds, the maths are against you making those kind of returns unless you’re brilliant at market timing, and good luck if you are. Over the next five years, you’re going to have to take more risk to get the same returns you’ve had the last five years, in my opinion. And that’s a difficult conversation to have with clients given you’ve had a five or six year bull run in asset markets to suddenly say oh we need to ratchet your risk up now, given the recoveries in some of the equity markets over that period.
PRESENTER: But just develop that point a little for me, I mean, Frank, in a sense I think what is being said in a way is this has been the perfect time to be running multi-asset money in that the risks, you know, low risk high reward, how do you go about working out who’s good at running multi-asset and who’s lucky and in the right place at the right time?
FRANK POTACZEK: And I think I could be cynical and sort of say you’ve got two great fund managers on either side of me saying ooh watch out the markets aren’t going to perform too well going forward because they’ve had a great run so far. But I think they’re absolutely right, we’ve been living in a really nice environment from an investment perspective. Past performance, over the past sort of 40 years you’ve seen those investment managers who have chucked money at the markets and it seems to have gone up because there’s been a bull market - a term that people call bull market operators. And I think 2007/08 has sort of shown those people that we’re able to manage money over the bull markets and the bear markets.
I think certainly looking out to the next three to five years those investment managers that have got experience across the cycles are the ones certainly that I’ll be looking to put my own money with just to make sure that when there are more challenging times, and it does seem to be more challenging times ahead, that they’re able to actually produce the mandates that they’ve set out that they will do.
PRESENTER: But, given that, I mean say you’ve talked, David, about a world that could look very different say in the next five years, say it does look very different this government and central bank efforts to support the bond markets have gone, we’re in a very different world, does that mean that the underlying investments you’ll hold in your lower risk strategies could be very different from what you’ve got today, or are you just trapped into holding…?
DAVID COOMBS: No, absolutely, they have to be different. You’re in a world now of negative real yields, probably, unless inflation continues to fall. Which it could do, it’s not impossible, but it’s not our core scenario. Then yes it will look very different. I think, going back, I just want to reiterate, bond markets have provided double digit returns some years over the last four, five years. So as a multi-asset manager, well you could have got the core wrong and had overweight bonds versus equities, you still did okay. That can’t happen from here now. Mind you, you might have said that 12 months ago with the gilt market having said that. But I suspect it’s unlikely to happen going forwards. So I think a lot of multi-asset managers have had a bit of a tailwind, let’s be fair.
I think if you want to then see who’s good and who’s not, look at the period of the last five or six years where you’ve had some poor monthly drawdowns from the markets and see how those managers did during those periods. There were some difficult periods, in ’11. Last year was no bed of roses either; there were difficult quarters and difficult sort of extended periods. You need to be a bit smarter in looking at the track record. Don’t just look at the rolling, don’t look at the calendar years, start to look at the points where markets are really difficult and what were their drawdowns - because ultimately do the underlying clients really understand? They don’t know what volatility is or Sharpe ratios. They understand when the portfolio is down 5% in a short period of time - that’s what risk really is.
PRESENTER: Okay. So look at some of those short-term periods where markets have been stressed is probably the best way of looking at what people might be able to achieve in the longer term.
TOM CADDICK: You’re looking at me Mark as if you’re wanting me to answer. So that was a statement rather than a question. I would agree, but I think there’s a little bit more to it on the multi-asset side, because I think this is a challenge, I mean Frank knows this better than all of us, because this is the exact area that they look at, but in trying to ascertain success within the multi-asset world is a very challenging one. It’s an area that the IMA seem to be sort of catching up on a little bit now, have probably lagged somewhat in the past, by broadly grouping sectors, you know, the traditional balanced of old we’ll now called let’s say 0 to 30 or - those are very very wide parameters for a peer group. And typically speaking when these are solution-type investments, these are investments that are designed with an objective in mind. These are outcome driven investments and portfolios that are designed with a client or with a client segment in mind.
So it’s very difficult to then group those into a very broad group and say ah well this first quartile’s great, bottom quartile’s not so great, when in reality what could be driving those returns is simply the strategic mix within those portfolios. They might have been designed to meet a particular risk return mix for a particular type of client. So it’s a real challenge and one needs to look at what are the objectives, what are the stated objectives and goals of that particular strategy.
FRANK POTACZEK: Absolutely. I mean if you look at the old cautious managed, as it used to be called, you suddenly found that you had 30% in equities. Those 30% in equities for a caution fund could be smaller companies or AIM stocks or whatever, that’s hardly cautious. And to pump up the performance numbers it was a cynical way of actually sort of doing that. So I think outcome-based is a much better way of actually looking at sort of these sort of things.
PRESENTER: Do most of these funds have good enough outcomes articulated or are they really general, you know, we’d like to do some good stuff over a cycle?
FRANK POTACZEK: Well I think when you look at risk targeted, the statements are there. You give yourself a boundary, risk-focused ones have not such a sort of targeted-risk levels to actually go for, but certainly yes I mean in terms of transparency is how is an adviser supposed to find the suitable investment for their clients if the investment aims are not stated, if there are no investment policy statements actually there. And I think certainly when you’re looking at multi-asset a certain direction of travel is needed, how you’re going to get there is something that advisers need to be able to make those decisions.
DAVID COOMBS: Yes, I think when your first screens could be looking at the prospectus or the fact sheet and if the investment objective says to generate an attractive return for a mix of assets I suspect you should move on.
PRESENTER: Okay. So that’s a tip from the inside; that should be a red flag. All right, but within that then, Tom, I mean you’re almost suggesting there that the peer groups don’t work, what you can actually just look at is list all of those multi-asset funds and then just look at a very clearly defined objective and see if they do. And if ten funds happen to have the same objective by all means call it a peer group, but we’ve sort of got it the wrong way round.
TOM CADDICK: I’d broadly agree with that. To be brutally honest with you, I think in the current form peer groups for this sort of area, for the multi-asset area don’t work, because they’re very generic. They give a very broad range of outcomes. And unless a fund is specifically being run to try and compete within a particular peer group, and typically you should be running a portfolio to meet an objective, a benchmark, whatever it may be, a risk return mix, then no, traditional single asset benchmarks and peer grouping doesn’t really work in the same way.
FRANK POTACZEK: Absolutely. I mean is an investment fund there to beat its peers or is there to produce an investment outcome for the client? And I think going back to basics, it’s designing funds and means funds are there to actually deliver a particular return for a particular client category.
DAVID COOMBS: There is some good news to the adviser here though, because yes what we’re articulating really it’s a bit more difficult to identify a good or poor performing multi-asset fund, because it’s not as obvious that we haven’t got those rankings. But given that it is more difficult and more due diligence is required then the adviser has more work to do and therefore can charge for that. And it shows that they’re definitely adding value for their clients, whereas opposed to, I’m not being funny, Investors Chronicle, a direct client can see if Woodford’s the best performing UK equity fund or not. In the multi-asset space, it’s much more difficult and requires a more consultative approach. And I think that’s a good thing for advisers that they have to understand more about the funds that they’re buying and understand how they’re likely to behave in certain environments.
TOM CADDICK: No, I think it’s a good point. I mean obviously the topic of this is outsourcing, and I know we’ve talked in previous sessions about calling it investment partnerships, which I think sums up a lot of what we’re really talking about here, because this is about finding the right investment manager who has a shared philosophy with you, the adviser, who has the approach that maps to your segmentation of clients, to your advice to clients, etc. etc. If you look at the single asset class peer groups, they are typically fairly homogenous in terms of their outcomes. You know, relatively highly correlated, they have a shared benchmark, and if it’s not an exactly shared benchmark it’ll be a very similar benchmark; in the multi-asset space, it’s a heterogeneous peer group.
So you have a wide range of outcomes, even though the IMA and others have tried to segment as best they can, but they’re extremely wide. So really it’s about focussing on that shared philosophy.
DAVID COOMBS: It’s all about research at the end of the day; making sure that the advisers are doing the correct research; making sure that there are so many different factors that go into what makes us something suitable for investment clients. So it’s no longer about past performance; it’s about risk-adjusted performance. How much risk has an investment manager taken to give you that return? Is it about consistency of return across the cycles? Are they outperforming over the bull market phases, are they underperforming in the bear market phases, or is there consistency across the aspects of it? So it makes an evolution of the research process that advisers possibly were using let’s say ten years ago into something a little bit more different nowadays.
PRESENTER: We talked a lot about return, and we’ve touched on risk, but, Frank, in terms of defining risk - we’ve only got ten minutes left, so it’s a very bad time in the programme to raise this as an issue, but what are the two or three as a rule of thumb sort of measures of risk that you think advisers should have a look at if they’re looking at funds. We’re not claiming to be comprehensive but.
FRANK POTACZEK: I think, certainly, taking a lead from the investment community over the past sort of 60 or 70 years, volatility or rather the variability of pricing of a particular investment has been seen as the major component of risk. The idea being that at any given time when the client wants to get their money back that a highly volatile investment could be down or it could be up in a big way. So volatility is there to actually judge investment sort of returns from that perspective. However, when it comes to the adviser, there are so many other different risks that the client is taking with their money. What is the likelihood of the max drawdown?
So volatility is something that you judge in terms of the portfolio. Max drawdown, the peak to trough movement, is there a massive difference between the highest and the lowest. Other things that you can look at is Sortinos, which is the risk-adjusted return, but only about the downside; as well as Sharpes. So I would say volatility is something that people should look at, and also the max drawdown in terms of judging funds.
PRESENTER: And, David, what about liquidity, because if you’re buying all these interesting new assets and instruments and somebody wants their money back, what happened?
DAVID COOMBS: Ultimately, one of the biggest risks is liquidity risk, and you only go far back as 2008 to understand why did the hedge fund industry have such a horrendous time, most of those funds had very low volatility. So volatility in itself wasn’t a good enough threshold for people to ascertain whether the investment was risky or not, because volatility’s only about price capture, and people who only value assets once a month will always have low volatility. So it is important to look at volatility. Absolutely, I wouldn’t dispute that, but on its own it is absolutely not enough.
One way of measuring liquidity risk is looking at drawdown, as Frank was alluding to. One ratio I think is increasingly getting some interest is the Calmar ratio, which looks at return for every unit of risk measured by drawdown that a manager achieves. And I think that’s quite a good way of looking at liquidity risk alongside volatility. It’s a start. Sortino is another way, but that’s based on volatility as well. So, again, there’s no very easy definition of risk at the end of the day. It’s knowing about the underlying investments, how often they’re priced, and even if you’ve got a daily dealing fund, if it’s investing in microcap UK equities, if that fund suddenly has to redeem 60% of the portfolio, you’ll find very quickly it’s not daily liquidity; it’s more like weekly or fortnightly liquidity. So you’ve got to look through. It’s complex, but that’s what advisers are charging for, and that’s the level of diligence they’ve got to do to understand risk.
PRESENTER: Just for those who haven’t come across it before, because you’ve mentioned a new measure.
DAVID COOMBS: Calmar ratio, C-A-L-M-A-R, yes.
PRESENTER: Pop that into Investopedia and have…
DAVID COOMBS: Yes, and it’s gaining traction, because it’s return linked to drawdown over the risk-free rate rather than return versus volatility. So yes look at the volatility, but remember an awful lot of very low volatile funds had drawdowns of 20, 30, 40%, including corporate bond funds, it wasn’t just hedge funds in 2008, just remember that.
PRESENTER: All right and, again, Tom, on this issue of risk, anything else that advisers should just keep an eye out for when it comes to risk?
TOM CADDICK: The problem with being left to last, is we’ve come up with some brilliant ones.
PRESENTER: Come on Tom.
TOM CADDICK: So there’s probably very little to add. I mean I think David and Frank have encapsulated it perfectly in terms of, you know, volatility is more of a professional measure that we all talk about and we use and it’s very useful. You’ve got value at risk which is quite a useful one to try and capture. I mean a lot of this is trying to build a picture of the expectation of loss, or the likelihood of loss. So things like the max drawdown, the relative max drawdown, all of these, it’s trying to give a feel for how exposed are we as a portfolio, how exposed am I to loss?
FRANK POTACZEK: I mean sorry I was going to say most of these things I mean it’s actually quite interesting that people think that we give predictions in the investment world, we don’t, we try and forecast. We try and look what the weather’s going to be like in 5, 10, 15, 20 years’ time and actually build portfolios to what we expect will happen. But then again we have to react to what the weather’s like on a weekly, monthly, six monthly basis based on what our long-term views are.
PRESENTER: Very quickly we’ve talked a little bit about diversification, correlation between assets, Tom, can you ever really achieve complete diversification portfolio, or has the lesson of sort of 2007/08/09 been that when it goes wrong it goes wrong for everything, there’s actually nothing you can do in a really nasty environment?
TOM CADDICK: I mean I think we all learned some very valuable lessons from that period, which was that spiking correlations, where people who had what they believe to be highly diversified portfolios, suddenly proved to be anything but that. We’ve talked earlier about asset allocation being a key driver. And I think it’s important to go back over that just for one second about what do we mean when we talk about asset allocation being a key driver of returns over time? We’re not necessarily talking about strong returns or weak returns, it’s just the returns of a portfolio, and I would wholeheartedly agree that asset allocation is. Because we’re not talking when we say asset allocation about day trading, we’re not talking about jumping in and out of markets, we’re just talking about the fact that over time typically different asset classes will behave differently, you do get some correlation of benefits over time, and that therefore having a different mix of asset classes within an asset allocation within your portfolio will be the key driver of your risk return mix over time.
So that’s your key mix within a portfolio, but can you ever be truly diversified? The lessons we learnt from that 2007/08 was that actually the key driver of lower correlations was gilts over that period, or developed sovereign. That was the only one that sort of held true to its correlation benefits and that we saw given the drying up of liquidity within the market in fixed income generally a lot of funds suffered badly. So for me it’s about owning assets. Not just because you think the returns are going to be sterling, you’re not owning assets, you’re owning different assets to do different things within your portfolio, and that sovereign still has a place, but it might not be the role that you think it has within your portfolio. There was an insurance or similar.
DAVID COOMBS: That’s a really important point; I think people have got to realise that asset allocation means having a number of asset classes that are not positively correlated, i.e. they’re negatively correlated. That means when some things go up some things go down. And as multi-asset managers we always want everything in our portfolio to go up, that’s human nature. I hate seeing things go down in my portfolio. And some say oh I want to get rid of that because it’s not doing very well, and then you sort of kick yourself and say don’t be such a stupid person, the reason you’re holding those investments that are going down is because they’re non-correlated. And when markets turn, hopefully, and CTA’s a great example of this, CTAs performed horrifically for the three years up until the end of 2013. You lost money on most CTAs; there were no trends in markets. Last year, they had a very very good year and provided 30, 40, 50% returns in a year that you really needed an uncorrelated strategy to work. But it’s that p word again; you’ve got to be patient. And many people I talk to say why would you buy gilts, you’re going to lose money! Well I probably will. Well why do you buy it if you know you’re going to lose money? It’s there because I don’t know that we won’t have a blacktail event in three months’ time, I’ll be absolutely glad I’ve got a ten-year gilt yielding 1%.
PRESENTER: And always be aware it’s an uncertain world and.
DAVID COOMBS: Be aware that none of us have got that sort of crystal ball, and we’ve got to try and plan for all eventualities, and that means we do buy some things that we hope to lose money on over the longer term.
FRANK POTACZEK: And if you look at Brinson et al, the famous paper that most sort of advisers quote, they say it’s about the variability of returns, not a driver of actual returns. And I think that’s very interesting that when most of the asset classes that these gentlemen use are actually exchange traded, there is a price being made on them. You know, the whole aspect of is if there’s a price it means it’s liquid; if there’s no price it’s illiquid. So unless you go off and actually stick some wine or some art in your portfolio that is very very difficult to get rid of then the ability to truly diversify is difficult.
PRESENTER: Okay, we’re almost out of time. I’m going to ask each of you for a final thought. Multi-asset, as we’ve discussed, has changed so much in the last few years, how much is it going to change in the future? Sort of prediction moment, how might it look different in five, ten years’ time? David Coombs?
DAVID COOMBS: I think there’ll be less multi-manager in the multi-asset space. I think in a world of negative real yields and lower nominal returns then price will be very important in terms of the value of those returns. So I suspect that there’ll be more passive used, there’ll be more direct investments in multi-asset funds, because high TERs will be a massive headwind in the face of very low returns from bonds and lower returns from equities.
FRANK POTACZEK: I suspect there will be a whole range of different asset classes being invented and being incorporated into different funds. I think investment mandates will be tightened up and will have more of a promise of what returns will be going forward.
PRESENTER: Tom Caddick, a final thought?
TOM CADDICK: I think sophistication will continue to go up. I think price will come down and will continue to come down. I don’t mean just management costs, I just mean overall. So OCF, TER will continue to come down, which is a good thing. And I think that actually in the multi-asset world it’ll get closer to the adviser over the next five years or so.
PRESENTER: We have to leave it there, David Coombs, Frank Potaczek, Tom Caddick, thank you very much.
ALL: Thank you.
PRESENTER: And thank you for watching. The learning outcomes from this Masterclass are coming up next.
In order to consider the viewing of this video as structured CPD, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. Among the learning outcomes in this Masterclass are understanding the origins and drivers of multi-asset investing; identifying key sources of risk and return in an investment process; and the pros and cons of comparing multi-asset performance against benchmarks and peer groups. Please now complete the reflective statement to validate your structured CPD.