Multi-asset investing – how much risk can you afford?

Investors today face a challenging landscape, with high valuations across many traditional asset classes. Those high valuations come with low prospective returns, below-normal yields and, last but not least, high risk of significant drawdowns. More than ever, investors need to consider how much risk they can afford in pursuit of their investment goals. And more than ever, investors need the added value and effective risk controls that a compelling multi-asset outcome-oriented strategy can provide. Multi-asset has proved a very popular approach in recent years and the resulting plethora of fund launches make it difficult to find the right choice. At Russell Investments, we use a straightforward framework for identifying the appropriate option across multi-asset growth, multi-asset credit and unconstrained bond strategies.

Dynamic asset allocation is one of the hallmarks of successful multi-asset strategies. Adding value from tactical changes to the asset mix can be vital to keep returns on track, whilst diversifying effectively to control risk. But relying on managers’ tactical skills alone is unlikely to be a reliable way to create sufficient value for investors over the long haul. For long term added value, we need to identify the risk premia that add worthwhile value over time. The core skill of the successful multi-asset manager lies in deploying these risk premia in the right proportions at the right time in the investment cycle.

For multi-asset growth strategy (MAGS) investing, we believe that the single most important long term driver of returns will be the premium for investing in equity markets, which offer the highest rewards but correspondingly some of the most volatile returns. In the current environment, where equities are expensive, our portfolio managers (PM’s) are diversifying even more extensively than usual away from equities, for example into fixed income strategies in the middle of the capital structure. These investments offer some of the upside characteristics of equity, whilst offering greater downside protection in the event of market falls. (Downside protection is a key feature of our multi-asset approach and vital to preserving wealth over the long-term). For instance, credit securities such as High Yield have been one successful component of our MAGS diversification approach; more recently our PM’s have started to rotate into Emerging Market Local Currency Debt as this begins to offer better long-term value.

Those two credit segments are part of the wide array of opportunities found in multi-asset credit (MAC) strategies. For MAC, the key driver is the premium for taking on credit risk. The credit premium typically provides somewhat lower returns than equities but with less risk. We manage our MAC strategies with the same focus as in our MAGS portfolios, using dynamic allocation, effective diversification, and best of breed managers and strategies in all categories. As in MAGS, we also aim to limit portfolio downside risks, but MAC faces a constraint in this respect – this strategy is substantially exposed to credit risk throughout the investment cycle.

An Unconstrained Bond (UB) strategy can achieve more consistent but somewhat lower returns than MAC, because it has the freedom to diversify extensively away from credit and so to benefit from other risk premia. These can include the term premium, and premia from systematic exposure to for instance currency and real yield factors. In our own UB strategy, we use a core of short-dated higher-quality sub-investment grade credit, supplemented by diversifying and opportunistic strategies to enhance returns and improve the overall portfolio risk/return balance.

Using those three categories, investors can take a view on how much risk they can afford and the time horizon consistent with their objectives. MAGS investors will have the highest risk appetite and longest horizon. MAC investors will want to dial down their risk, and may envision a shorter timeframe. UB investors will want the lowest of the three risk profiles and the least volatility. Each of the three strategies represent valuable options for many types of investor. For instance, for Defined Benefit pension scheme investors, MAGS can provide equity-like returns over an investment cycle but with less volatility, whilst MAC and UB can both play a part in the derisking flight-path and in generating income during schemes’ mature phases. MAC and UB can also form sub-segments of a well-diversified MAGS portfolio. Striking the right balance between these three approaches can keep you on track to achieve your investment goals, with the level of risk you can afford.

Defining the three different multi-asset approaches:

David Millen, Investment Communications, EMEA Investment Division

david-millen

 

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