Matthew J. Bullock, Investment Director, Global Multi-Asset Strategies, Wellington Management, meets Francesca Fabrizi to discuss how multi-asset strategies can help investors
What is your outlook for markets, given how stretched some asset valuations look to have become, given central bank policy, populist politics and so on?
We are cautiously optimistic because while there remain many threats in the marketplace, there may also be opportunities. It’s important to think about opportunities because we don’t believe investors should completely avoid risk in portfolios.
Starting with the risks, there is political uncertainty in the US; uncertainty around Brexit, and the implications of a hard Brexit, which is the direction we seem to be heading; and around Europe, where we have several elections this year. All this creates uncertainty.
The overall theme for this year is being active in portfolios. The last three to five years saw a lot of emphasis on taking macro views, buying broad exposures and indexing in many cases to generate returns. With heightened uncertainty and stretched valuations – an unfamiliar environment – we feel we need to be much more active and tactical.
What this means for portfolio construction is that even though we have some broader market exposures, our emphasis across a number of different strategies takes more of an absolute return focus – where we seek to take advantage of pockets of volatility. For example, in relative value, we evaluate different markets against each other; in momentum, we assess market behaviour over a period of time.
Our other area of focus is what we refer to as ‘manager alpha’. Even in challenging times, some stock pickers or bond selectors can have a much greater chance of outperforming particular indexes. We look to remove the broader market exposure to try to isolate the outperformance.
What are the risks for investors?
We feel one of the main risks for investors is assuming that strategies that have worked in the past will continue to do so. For example, the sorts of broader multi-asset approaches that have worked very well over the last three to five years have had very large exposures to equities and bonds, and sometimes also currencies.
Looking forward, we have to think differently. With valuations stretched, we cannot rely on what has worked in the past. It’s very important that investors keep monitoring the way markets are behaving and, occasionally, when there’s a period of euphoria, try to take some risk out of their portfolios and move closer to an absolute return exposure.
How did the multi-asset absolute return sector perform through the market shocks caused by Brexit and Trump?
There are many varieties of multi-asset fund. Focusing on the multi-asset growth sector – which is referred to as diversified growth in the UK and could be referred to as absolute return in much of the rest of Europe – the last 12 months have highlighted that even this sector comprises very different funds.
Many funds, particularly more market-heavy ones, did very well following the Brexit vote, often because sterling fell sharply and they were unhedged. However, this highlights that these funds were running full currency risk. Some funds also did exceptionally well when markets rebounded strongly, which shows a heavy reliance on equities, bonds and currencies to generate returns.
That isn’t necessarily a problem, although many investors move into multi-asset investing for an absolute return or risk management focus, and it’s very hard to generate absolute returns when focusing on a very small number of asset classes. For example, in the week following the Brexit referendum, markets fell sharply and recovered almost as quickly. Many funds did exactly the same, which raises the question: if you are investing for an absolute return or total return and funds are behaving just like the market, what are you getting for your fees? In many cases, investors may be better off buying indexes and accepting the associated volatility.
In contrast, more absolute return-focused strategies performed okay last year, generating positive returns – which is their aim – but not nearly at the levels of some of the more market-reliant strategies. Going forward, investors should in our opinion look for strategies that haven’t relied on a few asset classes to generate returns, even though these may not necessarily have been the best performers recently.
Given the potential risks ahead, investors have to prepare themselves for shocks. An absolute return focus is what we feel they should be considering if they are concerned about capital preservation.
How would you rate the multi-asset absolute return sector’s performance and value for money versus other active and passive options?
Performance has been mixed. Some strategies have performed true to label, but most haven’t in our view.
After the year we’ve had, it’s healthy to debate costs and fees. Markets performed strongly despite major surprises, and absolute return-focused multi-asset funds didn’t by their nature keep up with that. That’s to be expected because diversification and risk controls necessarily mean the performance of such funds is likely to lag in a rising market.
I don’t believe investors should pay active fees for funds that behave exactly like the market, such as those that replicated the v-shaped recovery following the Brexit vote. What is worth paying for, though, is strategies that are true diversifiers that seek to add value and don’t just imitate the market. There is again a healthy debate about fees, although I don’t believe a race to the bottom, i.e., buying the lowest-cost fund, is the best solution. What’s more important than cost is value for money.
What are the main opportunities you see for investors going forward?
We see some interesting opportunities. For example, President Trump is proposing protectionist policies and fiscal stimulus, which we expect should, at least shorter term, be good for mid and small-cap US companies. Europe is largely unloved, although unloved sectors are sometimes where you can find interesting opportunities.
There are also opportunities in India, where several policies of Prime Minister Narendra Modi are starting to feed through into economic growth. Japan has long disappointed, although stimulative government and central bank policies and the focus of many companies on generating growth may also create opportunities.
These aren’t opportunities that can generally be accessed through broad exposures. We believe being active and very focused on finding quality names is more important than ever. A market that has run very hard and is reliant on expectations is likely to react with volatility or even shock if expectations prove wrong.
What are the main options available to investors looking to preserve capital?
There are different types of multi-asset growth funds: some rely on markets (technically, ‘beta’); others are more absolute return focused. We believe investors looking to preserve capital should consider absolute return strategies, which have more chance of preserving capital in periods of volatility. The disadvantage is that moving away from broader equity and bond exposures requires a bit more due diligence.
Important questions investors should ask include: Where are returns coming from? What is the relationship between equities and bonds in generating returns, and what is the correlation? What are the costs of running the funds?
Questions such as these will help investors to identify the best performing funds of the future. As I mentioned earlier, these may not be the best performers of the past.