Asset AllocationAugust 21, 2013

Multi-Asset: What Happened?

<em>In the first of a two-part feature examining multi-asset fund performance in Q2 2013, we ask providers why, despite many of them being actively managed, most lost money in the tapering tantrum that followed Ben Bernanke’s May 23 speech.</em>

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(August 21, 2013) — Risk parity funds may have endured a rough few weeks earlier this summer, but they weren’t alone—the wider multi-asset sector struggled too.

The reason risk parity funds took a hammering has already been covered widely in the press, not least by aiCIO (see here and here). But for the most part, risk parity is a passively run investment strategy, meaning the shock of the Federal Reserve talking about how it may, at some point, begin unwinding its quantitative easing programme, was hard for those funds to react to.

The wider multi-asset sector however, contains far more actively managed funds. They could have taken advantage of the immediate chaos, foreseen the outcome of a Fed speech, and employed enough derivative overlays to limit the downside—that’s what active management means, right?

In the aftermath of Bernanke’s speech many managers—and their clients—began to notice their diversified growth funds and long-only multi-asset funds weren’t looking too healthy.

Data from aiCIO’s sister title Strategic Insight shows around half of the largest 100 multi-asset funds lost money during that quarter.

The majority lost between 1% and 5% in the second quarter of this year, although there were some outliers that lost as much as 9%. Typically, those outliers were solely or heavily invested in emerging market debt and equities, which performed particularly badly in the days following Bernanke’s speech.

A few disclaimers: multi-asset has become an umbrella term, meaning everything from traditional balanced funds, 60/40 equity/bonds splits, all the way through to diversified growth funds, hedge fund-like long-only funds, absolute return funds, and beyond. It’s therefore difficult to provide direct comparisons on how each type of fund performed.

That said, there are noticeable characteristics uniting the strategies that did well, and those that left a lot to be desired—particularly when you’re paying a manager to actively run them.

A brief recap:

What happened in May and June this year? Virtually all assets became highly correlated, very quickly.

Sara Morgan, managing director at BlackRock’s multi-asset client solutions, tells aiCIO her firm’s analytic tools showed that correlations in June were even greater than in the run up to the financial crisis’s beginning in 2008.

“Traditionally the places that would be safe havens when you see a big sell off in markets are cash, probably sovereign bonds, gold, and volatility strategies. What happened here was a big spike in bond market volatility,” she says.

Concerned about the growing correlation, Morgan built up some hedging strategies using put spreads and put options to reduce her overall equity exposure, sold out of the BRIC nations, ratcheted down her exposure to high yield and sold all emerging market debt.

All of which stood BlackRock in good stead, but it was still hit by poor performance in investment grade bonds and some residual bits of emerging market exposure.

“If you look across the board, there’ll be some commonality [in funds that suffered],” Morgan continues.

“Those that were heavily fixed income, particularly those funds with a lot of sovereign debt, are suffering because of their duration exposure. And those with investments in the BRIC nations or with emerging market debt, because those were asset classes that suffered a bit.”

Blackrock’s dynamic diversified growth approach lost 2.3% in June and 1.3% during the whole quarter, most of which it has since recovered.

Others spotted the fundamentals were looking shaky too. James Klempster, portfolio manager at Momentum GIM started taking equity beta off the table before April on the basis that, having run nowhere but up for 12 months, the fundamentals weren’t looking good for equities.

“I was surprised to see people adding equities at that time,” he says. “The thing that’s important to remember is these funds aren’t protected strategies and we must expect them to go down every now and then.

“But I’d distance myself from those that lost 7% to 9% in the second quarter. They were clearly taking on more risk they we did, but you’d have to look at their mandate.” Momentum GIM’s diversified target return fund lost 0.6% in the second quarter, but is has returned 8.5% in the past 12 months.

Others pointed to a fund’s structure to explain why some managers’ losses were deeper than others.

Overexposure to equity beta hurt a lot of managers, according to Bruce White, Legal & General Investment Management’s strategic investment and risk manager.

“Many people have become used to an environment where equities and bonds have been negatively correlated, and for the first time in a while we’ve seen that change into a positive correlation and even worse, one on the downside,” he says.

“What that tells you is that most funds, regardless of what they call themselves, are exposed to market return or beta. And I guess the natural question is: is that a problem?”

Actually the bigger problem, in White’s opinion, is multi-asset managers who have mis-labelled or poorly explained what they are there to do. The number of “absolute return” funds which claimed to do well in all markets concerns him.

STORY CONTINUES…

“Investors need to realise those funds rely on market exposure,” he warns. “There are lots of claims in the wider multi-asset space that they’ll deliver absolute returns in all environments. While it’s a nice idea, the question is, is it realistic?” LGIM’s diversified fund, which is largely passive and has an annual review of asset allocations, lost 2.4% during the second quarter of this year.

Lyxor Asset Management’s senior global macro and hedge fund strategist Florence Barjou agrees that those that floundered the most had serious question marks over their risk management.

“When you’re a long-only fund and everything correlates, you have no place to hide, this is why people lost money,” she says.

The worst-hit managers were fully exposed in the run up to the tapering tantrum, and then rushed out of those exposures at the worst possible moment, leading to the near double-digit percentage losses for the quarter, she continues.

“We cut exposure proactively when we saw correlations starting to converge,” she says. “We rely much more on momentum techniques and a discretionary way to manage risk.

“The only way to preserve returns is to be very reactive in your total exposure management and not shift your exposure back to cash.”

An interesting point, given it was the drive back to cash that caused the early summer markets wobble in the first place.

Scott Jamieson, head of multi-asset investing for Kames Capital is adamant the whole Bernanke speech was a masterstroke, well-planned and executed to perfection, and designed to keep the markets honest.

Economic historians will look back at the Greenspan years of the Federal Reserve and say the biggest mistake was not to sustain the awareness and understanding of the risk in asset markets between 2003 and 2007, he says.

Therefore, if you’re Bernanke, the only thing you can do to maintain a sense of risk awareness and limit the level of complacency is threaten to remove the punch bowl occasionally.

“He’s avoided the trap Greenspan fell into of never highlighting the negative case for asset markets, and he’s achieved levitation in bond yields to levels that my economic metric models suggest, given the fundamentals, are okay,” Jamieson says.

“He’s managed to transform a bond market where yields were incredibly low to one where yields are still low but not out of kilter with economic fundamentals by doing nothing. That’s the holy grail of central banking. By raising an eyebrow, cocking his head to the markets you achieve your aim without actually doing anything? In many ways he has played a blinder.”

Does that mean we could have anticipated it? Should managers have played it better? No, says Jamieson, and anyone who did manage to limit the losses did it by fluke.

“Who anticipated that on May 23 that would be the day Bernanke would make a statement? That was just luck if you’d got that right. You could have made that call three weeks, or three months before, and you’d have been wrong,” he argues.

“There’s no question that a number of the asset classes were at elevated ratings, and there’s no question that emerging market equities have been a dog for three years. Developed markets have outperformed them since 2010.

“The natural thing for people to do in that environment would have been to buy hard currency bonds because they’re a defensive asset, but they took as big a smack at the end of May because cash was being re-rated. Even the dollar fell. The only one to do okay was the Japanese yen and who thinks the yen is anything other than a sell or a structural review?”

In Jamieson’s eyes, the best thing for investors to do is accept that you can’t call the markets, and to look to the fundamentals to drive your long-term investment thinking. Kames’ diversified growth fund lost “somewhere between 5% and 6%”.

aiCIO did attempt to speak to Standard Life Investments about arguably the best-known diversified growth fund, Global Absolute Return Strategies Fund (GARS), but the company failed to return several enquiries for comment. We can tell you that its performance was typical of other DGFs, losing 1.36% in the second quarter according to FE Analytics data, and returned 4.96% for the last 12 months.

So is it worth paying out for an active manager in this environment? Active managers will of course say yes, but the fact remains that some passive strategies—which are far less volatile—performed better in times of stress.

“You may have periods where an active strategy does less well than a passive strategy, simply because the manager has a mindset they’ll be hurting investors a lot more if they lose a lot of money, compared to losing some of the upside,” said Russell Investments’ CIO of multi-asset solutions and EMEA, Christophe Caspar.

“That’s good in the short and middle terms, but in the long term the effect of compounding results is that a properly actively managed product which loses less during the down times is better. We try to have about 40% of the downside and capture 70% of the upside of equity markets. In a choppy, volatile market, it’s better to do that.”

Caspar also thinks that diversified growth funds will be more segmented in future, between the ones that aim to make equity like returns over five years and those looking for lower returns and lower volatility, in order to cater for both sorts of investor.

All economists agree that we are entering a period of sustained volatility, likely to last for at least 24 months. In part two of this feature into multi-asset funds, published tomorrow, we ask managers what more they can do to lessen the impact of bond and equity disruptions and correlations spikes in future.