It is crucial that trustees evaluate multi asset strategies by the right criteria argues David Vickers, senior portfolio manager at Russell Investments
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First and foremost, when selecting a multi asset fund, it is important to find one whose primary objective meets yours, and whose management style is single-minded in this pursuit. This may seem obvious, but there are many funds whose efforts are still channelled into beating a peer group or benchmark, which bears no relation to a pension’s obligations.
Look for a fund manager who cannot say “I’ve done a good job, beaten the benchmark and the peers, but still lost X%!”
Risk should not be a residual output of a static asset allocation policy. The risk you take in 2009 should be very different from the risk you take in 2015, given drastically different return expectations. This is particularly relevant to pension funds which during times of weakness in risk markets may also be suffering an increase in any un-hedged liabilities.
With regards to the multi asset fund itself, I would suggest that there are three key tenets necessary to increasing the probability of success – although there are of course no guarantees!
The risk you take in 2009 should be very different from the risk you take in 2015, given drastically different return expectations”
A robust investment process is crucial to creating sustainable performance. It is not possible to quality control the investment outcome – we deal after all with imperfect information – but it is possible to quality control the investment decision-making process. This enables us to focus on what matters to markets, ignore the noise and, importantly, remove as much as possible the behavioural bias that exists within us and can impede success.
By way of an example, our process has three pillars; valuation, cycle and sentiment. These are combined over different horizons to form the backbone of our dynamic asset allocation policy.
Valuation looks at the compensation on offer both in absolute and relative terms. You have to start with this analysis, as it also references the risk you are taking – low return expectations can create an asymmetric risk return profile. However, one has to accept that valuations only slowly mean-revert, as Keynes said “markets can remain irrational for longer than you can stay solvent”.
The next pillar is the analysis of the business cycle. This encompasses the economic, policy and corporate earnings dynamics whose influence applies most powerfully, squarely in the middle of our tactical timeframe of 0 to 5 years.
Finally, we take the temperature of the market by looking at a variety of sentiment and momentum indicators, which highlight whether the market is currently over-optimistic or pessimistic. A combination of these three factors, scored both quantitatively and qualitatively, creates a robust decision making framework and enables us to navigate changing markets in a consistent and relevant manner, mitigating the behavioural biases that beset markets.
The opportunity set is ever-widening and the tool kit ever-expanding”
A deep resource, experience and a commitment to multi asset is also imperative. The opportunity set is ever-widening and the tool kit ever-expanding. To capture, analyse and decide upon the best method of implementation takes significant specialist resource. Specifically, if employing a funded approach, an open architecture platform is essential as no one asset manager has the monopoly on the best asset class specialists.
The last tenet of the assessment process, which arguably should be the first step, is the management of risk.
As mentioned earlier, risk management should be a core discipline and risk should be deliberately taken not accepted as a by-product. This is never more relevant than at the later stages over a market cycle, where we find ourselves today.
The protection of the compounding potential of previous gains is a powerful way to achieve objectives. If you lose 50% of your money, you have to make 100% just to get back to the same nominal level. This simple fact highlights why risk should be actively managed as losses can be so destructive, and are often amplified by behavioural biases.
Risk should be pragmatically applied and embedded into the process”
All fund management houses will monitor risk, and many will have sophisticated systems based on volatility and value at risk (VAR), but these can only tell you so much, and, in the latter case, the best of your worse outcomes! Such tools should not be solely relied on. Risk should be pragmatically applied and embedded into the process.
Valuation risk needs to be soundly understood, as an expensive asset is a risky asset, irrespective of what recent volatility may purport. For us, it is a good discipline to routinely start over with a portfolio and ask, given what I perceive in markets, how much risk should I take today in pursuit of my aims?
Assessing multi asset fund management teams on these three criteria will, I believe, set investors on the right path, remembering, of course, to ensure that the fund’s objectives – both return objectives and risk budget – are aligned to their own.
David Vickers is a senior portfolio manager at Russell Investments
All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate. Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.