How Multi-Asset Investing Became So Popular
Widely diversified asset allocation methodology offers promises of capital preservation, a boon post-crisis.
Art by Valeria Petrone
After getting crushed in the stock market in 2008, many people grew disenchanted with the long-time investment mantra that equities were the one true way to wealth. That smug bromide rang hollow when the financial crisis slashed many stock portfolios in half.
So, diversifying your holdings has become a strong imperative in the investing world. That’s why multi-asset strategies, which combine stocks, bonds, and a panoply of other assets, seems like a good idea on its face. It promises capital preservation and sometimes delivers superior returns. This technique has grown popular as a result.
David Swensen, Yale’s investment chief since 1986, is among the first to adopt it, using an amalgam of private equity, real estate, and other seeming exotica, to amass a scorching investment record. That has enticed many imitators to follow suit. Achieving “superior results over the long term,” he wrote, involves “unorthodox and rational asset class allocations.”
For the average investor, multi-asset is most prominent among target-date funds (TDFs), which have become the default offering among 401(k) plans. In their most elementary form, these vehicles start stock-heavy when an investor is young and over time gradually shift toward bonds, a more conservative investment best suited to the older set.
TDFs have grown five-fold since the financial crisis, reaching $1.09 trillion in 2018, a Morningstar report concluded, with an estimated $40 billion added last year. “The default strategy is overwhelming” in delivering TDF expansion, noted Tyler Cloherty, head of Casey Quirk’s Knowledge Center, a research operation. Another variant, called a collective investment trust, which is the province of institutional investors, has also done well.
A Multi-Hued Palette
For a long time, the go-to method of diversification was a 60-40 stock-bond portfolio, popularly known as a balanced fund. Many target-date portfolios persist in using just the two-sided mix.
In the crash year of 2008, when stocks lost almost 30% and bonds gained around 3%, balanced funds were down around 12%, according to a study by Vanguard Investments. Considering the magnitude of the downturn, the wasn’t too bad, although it could have been better.
But multi-asset now goes far beyond the simple stock-bond duality, which seems insufficient to deliver the best diversification. The most salient problem with the basic pairing nowadays is that bonds are paying low interest rates. Their ability to score capital gains is limited because rates don’t have much left to fall before they hit zero. “These don’t work as well as they used to,” observed Deepak Puri, CIO Americas for Deutsche Bank Wealth Management.
There’s a strong argument for Swensen-like multi-asset funds that range beyond stocks and bonds, adding solid helpings of commodities, real estate and all kinds of other asset classes. With such an array, the thinking goes, you’re best protected when recessions thunder in.
The growth trajectory for multi-asset is steepening, as more and more asset managers adopt it. Let’s look at a growing sub-set of the investing world, private markets, a largely institutional realm composed of private equity, hedge funds, real estate, natural resources, and other strategies whose assets aren’t publicly traded.
Multi-asset, which rolls up all the individual strategies, in 2019 composed 13% of the private asset universe and is expected to return 4.5% annually through 2024, according to Casey Quirk, an arm of Deloitte Consulting. That isn’t a daunting growth rate, but the figure should have a decent chance of holding steady, while public markets lurch around, especially in the next recession.
With so many different asset combinations possible, once you get past the conventional stock-bond combo, the mix can be tailored to different tastes and risk tolerances. Among mutual funds, Cameron Brandt, the research director at data provider EPFR, sees a divergence of multi-asset preferences by generation.
Baby boomers have long favored the more traditional balanced fund approach, he said. Generation X and millennials lean toward total return strategies, which encompass a broader-spanning mindset, and often has a tilt to bonds.
The broader style appeals more to young people, who “have different horizons and aren’t into houses, getting married, and retirement planning,” as their elders are, Brandt observed. The original total return concept was created by Bill Gross at PIMCO: He patched together a disparate amalgam of fixed-income securities, from asset-backed securities to emerging market bonds to high-yield, and nimbly rearranged his compilation to track his macro viewpoints. Lately, fund flows are dwindling for balanced and in late 2019 total return took the lead.
Origins: Talmud, Twain, Markowitz, and Dalio
The diversification concept has been around for centuries. The Jewish Talmud, written thousands of years ago, advises: “Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve.” Mark Twain lambasted the folly of concentrating your wealth in Pudd’nhead Wilson, with his tongue-in-cheek suggestion: “Put all your eggs in one basket—BUT WATCH THAT BASKET.”
The intellectual godfather of multi-asset is Harry Markowitz, an academic who formulated a method of measuring how a collection of assets, as he put it, “moved up and down together.” To Markowitz, now a professor at the University of California, San Diego, everything is inter-related. His Modern Portfolio Theory, or MPT, gave investors a template to gauge risk versus return, and won him a Nobel Prize in 1990.
Still, such insights needed an asset manager to put them into effect for the investing public. Ray Dalio, celebrated as the founder of Bridgewater Associates, the world’s largest hedge fund firm, was that pioneer. He launched the All Weather Fund in 1996. Initially, Dalio wanted to find a way to safeguard his family’s wealth for generations to come. Then he figured that others could benefit from his vision. The concept gained momentum after the 2008 financial crisis.
Dalio called his method risk parity. Funds employing it used rule-based investment strategies that range further afield than traditional stocks and bonds. The idea is to put together a diversified portfolio where each asset class contributes an equal amount of risk, so returns are not primarily driven by stocks. The allocation is derived from historical research on how each asset performs and relates to other groups over time.
The concept that Bridgewater created has blossomed into a movement. As a company white paper described it, the strategy ended up “fundamentally changing how the biggest capital pools in the world manage money.” The goal is to hold four different portfolios with the same risk, with each doing well in a specific investing climate: growth rises, growth falls, inflation rises, inflation falls. In other words, to invest in balance for the long run.
Small wonder that Bridgewater won CIO’s Innovation Award this year for multi-asset investing.
As Dalio argued in a Bridgewater video, there often will be a “ruinous environment for some asset classes.” Bridgewater’s answer to that harsh reality has been a breakthrough innovation. It hardly is perfect, of course. All Weather gained 16% in 2019, although it has had some bad years, such as 2013 and 2015 when it lost money.
When Multi-Asset Doesn’t Work
The 2007-09 financial crisis had a way of humbling even the most brilliant mathematical constructs. Like so much else, MPT came a-cropper during the meltdown, as investors dumped almost everything in favor of safe US Treasuries. Normal distributions of risk and return were thrown into disarray with the explosion of the sub-prime mortgage bomb.
The psychological allure of a seemingly limitless housing boom and the ease of mortgage financing, Professor Markowitz complained, overcame the rational system that MPT put in place. “The layers of financially engineered products,” he remarked ruefully, “combined with high levels of leverage proved to be too much of a good thing.”
In other words, human miscalculation can deliver a body blow to multi-asset investing. While math-based, this is not an exact science. Nothing in investments ever is. Other than TDF mutual funds, which usually buy just index portfolios, active investing is often the watchword for multi-asset.
A mutual fund called Mainstay Marketfield was doing fabulously early in the last decade, with a focus on different types of equities, balanced by cash. Unfortunately, it made a bad macro bet, resting on its belief that interest rates would rise and stocks were overvalued. Wrong. Now known as just the Marketfield fund (Mainstay reflected its former affiliation with New York Life’s fund unit), it had three years of losses starting in 2014. The fund, which couldn’t be reached for comment, had massive redemptions, and its $20 billion in assets under management shrank radically. Today, it has a mere $183 million.
When Multi-Asset Works
A gold-star example of how multi-asset can be done well is First Eagle Global, which combines stocks (with the most going to international equity) and bonds, plus large dollops of bullion and cash. The gold and cash ballasts have kept it from turning in stellar returns, although it has lost far less than peers during the financial crisis and the 2015 mini-recession.
And it has done all this with minimal volatility, pointed out Morningstar analyst Tony Thomas. Plus, better returns than average. During the past 10 years, with a 7.7% annual average increase, it edged past its benchmark, the MSCI World, by almost two percentage points.
Until someone invents a sure-fire market beater that is consistent through the decade—highly unlikely—multi-asset will continue to attract admiration and interest.
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