Mercer’s preference is for schemes to consider allocating to hedge funds when looking at these types of return drivers. Ganatra says: “This is the most unconstrained investment style and enables schemes to access the widest range of returns possible.”
But if a scheme is unable to pay high fees, has liquidity concerns or insufficient governance budget then an idiosyncratic multi-asset fund is a good alternative. Ganatra says: “Schemes are comfortable with these strategies because they have reasonable fee levels and liquidity and are offered by large institutional firms.”
Pension schemes are also becoming more comfortable with more systematic approaches to multi-asset investing. Stevens says: “Investing in a hedge fund used to be the only way investors could access these sources but risk premia funds offer a cheaper alternative.”
Equity-like returns
Risk premia funds identify well-established sources of return such as momentum, value and carry across multiple asset classes. “The transparency of this strategy is part of the appeal,” Stevens adds.
The narrative of these strategies is relatively straightforward and easy for investors to grasp. Managers also work hard to communicate clearly about the fund’s performance. “When the strategies don’t work, managers provide good explanations about why they have failed,” Stevens says.
For example, following the election of Donald Trump many of the investment factor-based long-short equity strategies performed badly because there was a reversal in equity momentum. “This was clearly explained to investors which gave them comfort,” Stevens says.
Systematic funds are only one area of innovation in the multi-asset universe. And while this innovation offers schemes a broad variety of funds, very few of these new approaches have the necessary track record.
This compounds an existing problem: even traditional multi-asset funds do not have a sufficiently robust track record.
Saunders says: “The early dominance of the absolute return type multi-asset offerings, especially GARS, reflected a post-bear market belief that acceptable returns could be achieved with modest volatility and very constrained draw-downs, despite the lack of performance evidence.”
The case for absolute return multi-asset funds delivering equity-like returns with low volatility 10 years on remains unproven, he adds.
For example, the largest of the absolute return funds, Standard Life’s GARS, started well but has for some time missed its return targets. Saunders says: “This raises the question if it’s possible to achieve 4% to 5% growth in excess of cash returns from strategies which depend overwhelmingly on manager skill.”
The popularity of the absolute return multi-asset fund could start to wane, especially given the recent poor performance of some high profile funds. Saunders says: “Investors are starting to question whether the risk and return expectations behind their original allocation decisions were correct.”
But it is understandable why investors found the risk-return profile of these funds so attractive. “Every scheme would like to achieve equity-like returns as these are the default return-seeking assets and most have a deficit they would like to close,” Berriman says. But the downside of equities is its long-term volatility of 18%: in other words, this asset class will see its valuation fall by 40% from time to time. “That’s why a strategy which says it can dampen this volatility is so appealing,” says Berriman.
While the stated goal of multi-asset funds is appealing, it is hard to achieve. Berriman says: “If efficient market theory is even partially correct, then achieving equity-like-returns with half the risk requires exceptional manager skills.”
Some think this goal is misleading and problematic. Stevens says: “What does ‘equity-like return’ mean and does making this the goal potentially mislead investors about the risk they are taking?”
If the key objective of a multi-asset fund is to be diversified across a number of assets classes, then in strong periods of equity returns, this fund is likely to underperform. “Investors who selected a fund because of its ‘equity-like’ returns could feel disappointed,” Stevens says.
The ‘equity-like’ objective has to be framed over a full market cycle: after all, more diversified approaches prove their worth when equity markets fall. Stevens says: “Rather than using equities as a reference it would make more sense to frame the objective as providing real returns with a smoother return profile.”
Instead of focusing on these ‘equity-like returns’, schemes should think more carefully about what risk-return profile they need in order to meet their objectives. “Pension schemes do not fully appreciate how difficult it is to match a particular investment to achieve their precise goals,” Berriman says.
