Multi-Asset: What’s Next?

(August 22, 2013) – As we enter a new era of uncertainty, when volatility is expected to dominate markets for at least the next two years, how are multi-asset managers structuring their portfolios to limit losses?

Yesterday, aiCIO talked to multi-asset managers about how a large part of the industry was unprepared for market spikes—and how much they lost as a result.

Today, in explaining how they are planning on mitigating future unexpected market movements, these asset managers fall into two camps: those who advocate more sophisticated systems to mitigate losses through the use of derivatives and the ability to go short as well as long on investments; and those who analysed the fundamentals to adopt a much more long-term way of investing.

Neither selection can be labelled as wrong: the important thing for CIOs is to choose the strategy that best fits their circumstances.

So if you never want losses, even if it’s for a short period of time, what options do you have?

“The right position for that is probably cash, or maybe very short-term government bonds,” says Legal & General Investment Management’s (LGIM) strategic investment and risk manager Bruce White.

“But that creates the risk that you’re not investing for your medium and long-term horizons, where you need to generate returns.”

LGIM’s dynamic diversified fund uses some tools to mitigate losses. Before the correlation spike hit, it extended option protection, helping to offset some of the declines.

“We also had a relatively low level of exposure to government bonds, which performed poorly as yields rose,” White adds.

Drive for derivatives

Option strategies are popular with many asset managers. Russell Investments’ global CIO for multi-asset solutions Christophe Caspar had such a strategy in place in the run up to May, but the corrections weren’t deep enough for the 10% movement triggers to be set off.

“The options were in the money, but we left them in place in case there was a further correction of 5% or so,” he says.

“The US market only corrected 5%-6%, Europe had corrected 10%, so it worked there, but everywhere else the correction wasn’t strong enough to trigger the puts.”

Caspar advises picking a manager who won’t put all of its efforts into one or two big bets a year, and instead choosing someone which places moderate bets on a regular basis.

“It’s hard when you’re a multi-manager asset firm to prove that you’re good at everything, so open architecture helps you get the transparency,” he adds. “You want a firm that can get you access to the best investments, managers, derivative strategies and so on.”

The issue to watch out for is that your manager doesn’t lay on so many derivatives that it becomes an expensive insurance policy.

James Klempster, portfolio manager at Momentum GIM, said while his firm uses options as a means of protecting the downsides his funds experience, building in protection for the whole portfolio would be unnecessarily costly.

“Those funds that have a massive option floor across the whole fund, sure it’ll protect you from drawdowns, but it’s incredibly expensive on a long-term basis,” he says.

“You’d have to keep re-writing them options as the market goes up, otherwise they’ll end up much further out of the money. It’s do-able, but expensive.”

For Klempster, investors should look for a multi-asset manager with an alignment of interests, a pragmatic approach to asset management that isn’t too doggedly tied to using active or passive constraints, and one that has a robust and repeatable process.

“What’s absolutely crucial is that your valuation framework isn’t naïve to risk. Risk isn’t just a number, it reflects the risk of you losing money you can’t make back in the long term,” he continues.

“Volatility is just a manifestation of risk: it’s not the most important factor when investing.”

STORY CONTINUES…

Blackrock has become increasingly tactical with buying its protection over the past five years. Sara Morgan, managing director of its multi-asset solutions, says as a firm it doesn’t believe in having constant insurance in place, but would utilise put and call options where prudent.

Other managers are more specific with their asset allocation choices, including Lyxor Asset Management’s senior global macro and hedge fund strategist Florence Barjou. Part of her scenario for the next 12 months is that bonds will be “a losing asset class” and that interest rates will increase. This has led her to cut Lyxor’s bond exposure far more aggressively than her peers.

Back to basics

Unlike others, Barjou is not a fan of options, preferring momentum investing strategies with a dash of discretionary management.

Kames Capital is also dislikes playing around with derivatives. Head of multi-asset investing Scott Jamieson is a long-term thinker, who prefers to look at the fundamentals, instead of trying to play catch-up with market movements.

“Whatever the nuances of market management coming into the Fed, the backdrop is the US economy is exhibiting much greater resilience and strength than anywhere else, so US assets should on a structural basis, do well,” he argues.

“It also supports US bonds because policy is biased to become more bond-friendly as the central bank is minded to tighten, compared to other locations where policy is likely to be looser for longer.

“In this time where there’s going to be more volatility, you have to take the long-term view based on fundamentals, more than ever before. Liquidity is not a fundamental, it’s a tactical phenomenon that has been pressed into markets, designed to restore fundamental health.

“It is inevitable that health at a fundamental level will return on a non-uniform basis, and it’s important for investors to focus on where it’s working most and to buy things that are fundamentally attractive.”

Jamieson also believes further tough times are ahead for emerging markets. As the US withdraws its liquidity prop, money will flow out of the region, potentially causing a new emerging market crisis on a level with what Thailand suffered a dozen years ago. This time though, he believes it’ll centre on India.

Robert White, client portfolio manager at JP Morgan Asset Management, also worries about leverage.

“There are some time-tested prudent rules for dealing with money management: minimal amounts of leverage, manage the amount of liquidity and concentration and try to be in a position with diversification [that allows you to] take advantage of any potential sell-offs or turmoil in the market,” he says.

He also warns against a US trend for picking star fund managers over asset allocation. Seen as more of a retail trend in the UK, apparently the desire to find the next Bill Gross or the next Ray Dalio is still prevalent Stateside.

So roll up, roll up investors. You picks your fund managers and you takes your choice. But make sure it’s the right one, because multi-assets are in for a bumpy ride for the foreseeable future.

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