Cerulli Global Edge: Australian multimanager

Cerulli Global Edge, June 2012

In 2010, as the world emerged blinking from the global financial crisis and tried to work out what had hit it, Mercer’s Melbourne office put out an unusually honest statement about a new strategy. Mercer said it had “applied the lessons learned from the GFC” and had revamped its approach to strategic asset allocation in its multi-asset funds.

Not every manager with one of these funds admits to learning lessons in the global financial crisis, but there was certainly plenty to take stock of. Australians in multi-asset funds believed they were insulated against the collapse in stock market prices first by their own healthy economy (which in fact didn’t help its share prices at all) and secondly by the diversification of their funds. But many multi-manager products were structurally required to have up to 70% of the funds in equities, half and half between Australian and global, which offered no protection at all. Most superannuation fund default allocations continue to look like this.

Consequently, managers like Mercer have been having a rethink. The fundamental problem was that strategic asset allocation benchmarks were built around long-term models for returns, volatility and correlation. All of those long-term models went out the window during the financial crisis. Mercer’s conclusion was to change its approach to risk.

One example of this was to implement an idea it calls two-dimensional classification of assets. Instead of putting everything into a basket market growth or defensive, it takes a new model – the jargon is ‘growth defensive enhanced’ – which recognizes the mix of growth and defensive qualities within each asset class. In practice, what this has means it greater allocation to physical assets like direct property, infrastructure and natural resources, in order to reduce the reliance on listed equity and similar assets, in the hope of getting a better risk/return trade-off; a greater delineation of assets within fixed income baskets, so that sovereign bonds and far riskier credit are no longer considered as a homogenous group; a more nuanced approach to alternative assets, which in Mercer’s case has included a focus on strategies such as insurance-linked securities and infrastructure; greater inflation protection; and more exposure to emerging markets (it’s possible they’re regretting that one so far).

Mercer is not the only multi-asset name to be looking afresh at its portfolios. MLC – which has been using multi-manager approaches for 25 years and has over A$50 billion invested through this method, much of it multi-asset – announced in April new strategies for four of its MLC Horizon series of portfolios, all of which are multi-asset. They included making an allocation to a multi-asset real return strategy, as well as appointing new managers. MLC pitched the changes as increasing diversity of investments, strategies and managers, as well as providing greater preservation of investors’ capital in difficult markets.

Generally, one change in funds like these since the crisis has been an increase in the amount of latitude given to dynamic asset allocation in uncertain times. At Threadneedle’s multi-asset fund, for example, asset class weightings are from 30 to 50% equities, 20 to 40% fixed income and 20 to 40% alternatives, all higher than the 5-10% ranges that used to be the norm. Mercer and MLC, along with another multi-manager leader, Russell, are all believed to have widened the asset allocation ranges on many of their funds allowing for a more dynamic stance on asset allocation when it is needed. It is understood that this greater range has been granted on the understanding that it will be used in a defensive way – to take money off the table when markets are highly valued or looking vulnerable – rather than as a tool to try and generate a lot more alpha through market timing.

The MLC Long-Term Absolute Return fund gives us an example of just how far some multi-asset funds have diverged from the classic Australian mainstream of plain old 70/30 growth/defensive allocations. According to its product disclosure statement, as of December 31, the neutral target allocation would be just 9% Australian shares, 39% unhedged global shares, a further 10% hedged global shares and 13% unhedged emerging market shares, 9% hedge funds, 8% global property securities, 17% multi-asset class real return strategies, 6% Australian inflation-linked securities and 3% global multi-sector bonds – which comes to 114%, the extra 14% coming from gearing. All of these allocations can move substantially, but the idea of an Australian-domiciled multi-asset fund with just 9% in local shares and almost nothing in any kind of Australian debt would have been unheard of a few years ago.

A more typical example would be the AMP Capital Multi-Asset Fund, which aims to provide a stable medium term real return of 5.5% above inflation on a five-year rolling basis, and gives its managers the ability to change the investment mix when they think it appropriate. When last disclosed in April, it had a 55.4%/44.6% growth/defensive allocation, and like the MLC product was notably light on Australian equities, with just 10.6%; however unlike MLC its remaining equity exposure (12.98% global equities, 10.7% emerging market equities) is more modest, with much more of a focus on investment grade credit (13.7%) and cash (18.9%). Characteristically of modern multi-asset funds, it maps out separate allocations for commodities, private equity, opportunistic alternatives, distressed debt, direct infrastructure and absolute return (both growth and defensive), although between them they accounted for just 10.7% of the fund as of April.

Another characteristic of multi-asset funds in Australia is that, these days, they are expected to take a view on the currency – even if that view is hedging it out completely. That is a natural approach in a country in which the strength of the currency has eroded gains from assets elsewhere in the world, and made losses even worse. Despite a landmark bull run in the gold price, for example, most Australians have largely come out flat because from where they stand, the US dollar has depreciated as much as gold has appreciated. So, for example, the Aberdeen Capital Growth Fund, a multi-asset product, allows currency hedging for international share assets to range from zero to 100%, and for fixed assets, from 90% to 110%.

Alongside this, there has been a revival in a particular field of multi-asset funds focused on yield. These are generally called multi-asset income funds and tend to invest in a range of cash, fixed income and sometimes alternative yield assets. These are targeted at retirees looking for stable yield, and are designed with liquidity and downside protection at the forefront. An example here is the Aberdeen Multi-Asset Income Fund, whose underlying asset classes can include fixed income, cash, Australian equities and listed property, but with the equities very much tilted towards dividend plays.

The interest in non-conventional asset classes has brought mandates to some relatively unfamiliar names in Australia. Underlying managers on Mercer’s multi-asset funds include Magellan and RARE on listed infrastructure, Westbourne Capital on unlisted infrastructure, H3 Global Advisors on natural resources, Amundi on overseas sovereign bonds, and Winton Capital on managed futures.

Another development in recent years has been for bigger managers to diversify the range of styles they have within each asset class within a multi-asset fund. Blackrock, Colonial First State, Schroders and UBS have all done this, often by combining several internal capabilities.

For all that, multi-asset funds are believed to be suffering outflows; fund researcher Lonsec reports that “most managers experienced significant outflows in 2011”. There is also a sense that, particularly among funds that are both multi-asset class and multi-manager, there has been a tendency to over-diversify to the point that they go to a great deal of effort and fee cost in order to do little more than track an index.

Nevertheless, there is evidence of managers staffing up in this area. Last June, for example, Colonial First State announced an expansion of its multi-asset team as part of a broader expansion in Australia and Asia; this in turn followed the absorption of a New Zealand-based multimanager team, from Commonwealth Bank subsidiary ASB Group Investments, into Colonial First State. Doing so, Colonial reported increased interest from clients in multi-asset, particularly from Asian asset owners. It also said that the growing portion of superannuation savings in Australia entering post-retirement would fit multi-asset approaches.

Fee models vary significantly. BlackRock, for example, lists four funds for sale in Australia under the multi-asset tag (although some of them would elsewhere be considered balanced funds, without the ability for tactical tilts commonplace in multi-asset). All four have completely different fee structures: the Asset Allocation Alpha fund charges a 1% base plus a 20% performance fee; the Global Allocation Fund, 0.2% base plus 12.5% performance;  the Wholesale Balanced Fund 0.95% with no performance fee; and the Wholesale Managed Income Fund 0.8% with no performance fee.

This perhaps reflects a challenge of definition for multi-asset. Morningstar Research in Australia considers multi-asset within its multi-sector category, which puts them in with a host of diversified and balanced funds which don’t necessarily take active allocation decisions.

As always in Australia, it’s one thing to tell a good story about a fund or investment style, but the key to it working is to convince the nation’s all-powerful financial planner dealer groups to embrace it. There is a school of thought among some planner that a multi-asset fund is taking away a role that they see as their job: deciding the best asset mixes, and the best funds to provide it. At the same time, though, planners are acutely aware of the need for risk-adjusted returns from a diversified portfolio since the financial crisis, so this is not a bad time for multi-asset funds to be gaining traction.

Takeaways

• Multi-asset funds are evolving in Australia, with changed methods of assessing risk, and a renewed interest in alternatives.
• For external asset managers, Australian equities appear to be of declining importance in these funds, while segmented fixed income funds – focusing on a particular area, like credit or global sovereigns – stand to gain.
• Bigger managers are adding diversification of style within individual asset classes. There is a danger, though, that too much of this creates little more than an index fund.