The 7 golden rules of multi-asset investing
One of the legacies of the global financial crisis has been the phenomenal rise of multi-asset funds. Before the ‘Lehman moment’, many investors had a conventional approach to fixed income and equity allocations. Heavy home biases to equities were common and there was tendency to overlook key risk factors in fixed income security selection such as duration, currency and liquidity. To make matters worse, many investors were failing to explore the full breadth of opportunity within single asset classes.
The fallacy of this strategy would be revealed when the global financial crisis struck markets and investors suffered large draw-downs from supposedly well-diversified portfolios. As Warren Buffett once remarked, “only when the tide goes out, can you see who has been swimming naked”. This was a wake-up call to the investment industry and the concept of multi-asset was thrust to the forefront as a solution.
Since then, demand for multi-asset products has surged. With now hundreds of competing strategies, investors and asset allocators face a difficult selection process. While all reside under the ‘multi-asset’ banner, these funds take very different forms and follow different approaches to risk management. In my view, while all investors will ultimately have different objectives, successful multi-asset investing must always adhere to the following seven principles.
Forget about benchmarks
Without any doubt, flexibility is a multi-asset manager’s greatest strength, but it is a muscle that needs to be flexed. Failing to be bold when adhering to your investment objectives, is failing your investors. At times last year, we had a 55% asset allocation in equities, which we then reduced to as low as 18%. This was to minimise the drawdown risk for investment, but also to maximise the potential returns within the risk parameters of the fund. We always entertain the entire spectrum of possibilities and being able to invest without a benchmark is a big advantage of multi-asset investing.
Investors must react to the changing nature of markets. While it is still too early to assess the impact of the political events of the last 12 months (Brexit, US election), it has become clear that it is more vital than ever to react quickly when managing funds in the future. While every good fund has a long-term target from which it should not stray even during small fluctuations, it must also be able to react quickly when action is needed and assess the potential impact of seismic political risks.
Bring something new to the table
Both institutional clients and IFAs face challenges. Institutional implementation timeframes can mean it is difficult to react to market dislocations. For example, in 2016 we saw a major credit dislocation, but most pension funds failed to gain exposure until the latter stages of the rally.
Macro-economic themes are also shortening. Previously, multi-asset investors could anticipate how macro-economic themes would play out over 2-3 years or longer, but now they are being measured in months. Dynamism is the key. As an illustration, Brazilian foreign currency debt showed great valuation prospects in early 2016 but within 3-6 months, this had largely disappeared. IFAs also face challenges in covering the full spectrum of market opportunities and may not have the expertise in more esoteric areas.
Explore the asset class spectrum
It is important to always be on the hunt for ‘multi’ across the entire investment universe, but it is vital to assess the full opportunity set within a single asset class. On the bond side, we demonstrated this by an investment in a Turkish government bond issued in US dollars. We built this position after the US election in November 2016. Even when the currency crisis surrounding the Turkish lira began at the end of the year, the ten-year yield remained steady at just under six percent. We now have a significant position in the portfolio. In an environment where government bonds are under pressure and interest rates are low, this bond is maintaining a yield of 5.5%.
The days when you could merely increase your bond allocation to protect the downside are over. As multi-asset investors, minimising draw-down periods is paramount. Thus, we must all now implement alternative protective mechanisms. This means always being creative. Fortunately, if you have a flexible mandate you can implement an array of protection strategies. These include, put options, active currency management and various hedging strategies.
Don’t follow the crowd
It is easy to say you don’t follow the herd, but in multi-asset investment you must do it. This means swimming against the tide of sentiment. This can feel uncomfortable for short periods but the long-term gain is what drives outperformance. For example, we have taken a position in unloved Mexican debt where valuations are attractive following Trump’s bellicose attitude to Mexican-US relations. We also invest in Polish domestic bonds. Real interest rates are extremely strong here and the zloty is weak compared to the euro.
Remember: there is always value somewhere
As a team, we are never worried about running out of ideas. In a universe encompassing 23 countries in which every asset class is carefully scrutinised, there is ample room for creativity. We are always ready to look at different and new opportunities. Our philosophy is that we must also go the extra mile for a little more added value.
Hartwig Kos, co-head of multi-asset at SYZ Asset Management