Spred the risk for steady returns

Any financial adviser worth their salt will tell you that the key to achieving a steady long-term return on your investments – without |taking too much of a risk – is diversification. Investing all your money in one company’s shares, for example, could see you lose everything in one go if that business was to go bust. But, by spreading assets across two companies’ shares, you can take comfort from the fact that if one went under, you would still have the money you invested in the other.

The more you diversify, the more you reduce the risk in your portfolio, and by spreading your money across different stocks, as well as different asset classes – such as bonds, property, commodities and cash, which all move in different cycles – you can lower the risk even further, while still preserving the potential to achieve decent returns.

The tricky part, however, is deciding how much to allocate to each type of asset. If you had put most of your money in stocks and shares, property or commodities over the last year, you would have seen significant losses in your portfolio. Only if you’d allocated more heavily towards cash and government bonds would you be likely to have achieved a positive return.

Traditionally, investors have either ignored the relevance of asset allocation or relied on a financial adviser to make these decisions for them. But while some advisers have the knowledge and skill to actively manage their clients’ portfolios, many opt for a straightforward combination of bonds and equities – allocating a higher proportion to equities for those who claim they have a greater appetite for risk, or a higher proportion to bonds for those who prioritise capital preservation.

In recent years, however, a change in the financial regulations has begun to make it easier for individual investment funds to provide a much more complex and dynamic asset allocation all in one product. These so-called “multi-asset funds” aim to be a one-stop shop for investors, spreading their money across multiple asset classes, some of which would not necessarily be accessible to the average financial adviser. The allocation to each asset is also varied on a daily basis, in a bid to maximise investors’ returns.

So, will this be the answer to all our financial planning needs?

The one-stop shop

Alan Steel, of the financial advisers Alan Steel Asset Management, says he believes multi-asset funds are a great idea but have been relatively disappointing so far in terms of their returns. However, he concedes that there are some notable exceptions – highlighting M&G’s Cautious Multi-Asset fund as one that performed very well over the past year. Over the last 12 months, it has lost only 3.1 per cent of its value, at a time when only a handful of investments have made any positive returns at all.

Steel says that the fund’s manager, David Jane, tells investors that this is a fund he designed for his mother. When the times are good, his mother is happy to only participate in 70 per cent of the market return, but when times are bad she wants her capital protected.

This is ultimately what multi-asset funds strive to do. For investors who are willing to take greater risks with their money in search of greater returns, these are probably not racy enough. But for those who find it hard to see a third or more wiped off the value of their investments in less than 12 months – as has been the case for those who have predominantly invested in equities in the past year – these funds are attractive.

Trevor Greetham is the manager of Fidelity Investments’ Multi-Asset Strategic fund, which invests across five different asset classes – equities, bonds, cash, property and commodities. “The idea is that you’ve got a diversification across assets that behave very differently to each other, which gives you a smoothing effect,” he says. “If the tactical allocation is successful, it can preserve more of your capital when we’re in a scary stage of |the market – as we have been recently.”

Greetham’s fund has a benchmark asset allocation of 40 per cent in bonds, 10 per cent in cash, 5 per cent in property, 35 per cent in stocks and 10 per cent in commodities – but he has the power to vary these weightings up to 10 percentage points either way. At the moment, he has around 60 per cent in bonds and cash, just 2 per cent in commodities, and around 32 per cent in equities.

He says the advantage is that by constantly changing the weightings in his portfolio, he ensures investors are not locked into a defensive fund forever. Instead, Greetham adjusts the portfolio as conditions change.

Different strokes

The difficulty when considering multi-asset funds is that there are many different kinds. While all funds in the IMA’s Balanced Managed and Cautious Managed sectors invest in more than one asset class, most invest only in a combination of bonds, equities and cash. Of those that specifically call themselves “multi-asset funds”, some only invest in these three asset classes, while some take a broader view.

Nick Clay, for example, the manager of Newton Managed fund, invests only across cash, bonds and equities – and believes that this is all the diversification that investors need. He adds that his fund is much more transparent and cheaper, as he picks the individual stocks and bonds himself – rather than buying a range of other funds, like Greetham.

However, Tom McGrath, a fund manager at Apollo Multi-Asset Management, a new company which recently launched two multi-asset funds, disagrees with Clay. His funds are invested across as many as eight different asset classes, including areas as diverse as agricultural plantations and pigs.

Arguing the case for investing across a wider spectrum, McGrath points to modern portfolio theory, devised by Nobel Prize winner Dr Harry Markowitz. “Markowitz proved that the more non-correlated asset classes you use increases your chances of reducing risk and enhancing return,” he says.

McGrath does concede though that there comes a time when the benefits of taking on an additional asset class may be marginal, or even detrimental, to increasing returns. However, he admits that it is not always clear where this point lies. “Is four too few? Is eight too many? Maybe, but it’s good to have the flexibility to extend to that,” he says.

Andrew Wilson, the head of investments at wealth management firm Towry Law, is a strong believer in the benefits of diversification. Yet he points out that funds which have been disciples

of modern portfolio theory have not necessarily always performed that well. “I’ve seen plenty of multi-asset funds that have halved in value over the past year,” he says.

He says that many funds go wrong by trying to make calls on the top or bottom of specific markets – which is almost impossible to get right – while others have made bad decisions on where to invest. Last year, for example, many funds got burnt by taking a hefty exposure to private equity, which plummeted in value.

Wilson believes that |the key to success is picking the right asset classes, and then taking a valuation based approach to |changing weightings in these areas.

Extra costs

The downside to most multi-asset funds is that they work out more expensive than investing in a range of regular funds. Although their headline fees may not appear to be any more expensive, it |is important to find out what their Total Expense Ratio is.

Most multi-asset funds invest in other funds – and this is more expensive than investing in individual stocks or bonds. McGrath admits that if you’ve got the knowhow to build a diverse portfolio yourself – and the discipline to keep rebalancing the weightings as performance changes – you could save yourself money. However, he believes that leaving asset allocation to the professionals – and paying a little more for the service – will produce better returns in the long run.

Multi-asset funds: Are they right for me?

Brian Dennehy, of |the financial advisers Dennehy Weller, is not a fan of multi-asset funds. He believes individual portfolios need to be tailored to individual needs and argues that the concept of a one-stop-shop investment is redundant.

However, Darius McDermott, of the financial advisers Chelsea Financial Services, believes these funds can be a good first investment or core long-term holding. “Obviously if the FTSE 100 rises 30 per cent next year, then the funds aren’t going to do that,” he says. “But last year, when global markets were down around 40 per cent, the funds in this sector that we liked were down 10 to 15 per cent. So they’re not immune to a downturn, but they will help preserve your capital.”

McDermott recommends CF Miton Special Situations and HSBC’s Open Global Return as the two funds he favours in this sector. Alan Steel, of Alan Steel Asset Management, suggests the M&G Cautious Multi-Asset fund.

As ever, if you’re unsure which funds to go for, it’s worthwhile seeking professional financial advice. To find an independent financial adviser in your area, visit www.unbiased.co.uk.