Slower economic growth, declining interest rates and falling inflation that often disrupt equity markets can be expected to boost the returns of many of these assets, helping to offset equity market losses should they occur.
However, in the post global financial crisis world of zero interest rates and quantitative easing, the flood of liquidity that has washed across the global financial system has both increased asset class correlations and reduced opportunities to diversify.
Return characteristics
Understanding the differing return characteristics of the available asset classes and blending them together into an effective well-structured portfolio has therefore become more complex.
The growing popularity of professionally run multi-asset funds can be seen as a sensible and pragmatic response to this issue. They are now a core solution used by many firms of financial advisers, especially for clients with assets below the typical threshold for a fully bespoke discretionary managed account.
Generally created with a wide brief to invest across any asset class that provides an investor with a quantifiable return profile in a vehicle offering daily liquidity, multi-asset funds can be a flexible and proactive way of providing investors with a smoother long-term growth profile and which ensures investors remain within an appropriate risk framework.
The methodology behind multi-asset funds varies widely depending on the underlying investment manager. Some advisers work to match differing levels of equity exposure with the broadest range of other assets to create a range of investment strategies with clearly defined inflation and return targets.
Careful macro-economic modelling is required to produce a realistic range of expected asset class returns. Combined with statistical analysis of historic volatilities, this creates an efficient frontier of different strategies that matches off return expectations against the risk of loss.
As a result, the equity weights within each multi-asset fund will vary depending on the investment objectives and risk tolerances of the underlying investor. Older clients with a shorter investment time horizon or those simply wishing to maintain the purchasing power of their capital might require as little as 20 per cent of their portfolio invested in equities to achieve their long-term goals.
Younger investors with more aggressive return targets of 4 per cent or 5 per cent above the rate of inflation would require equity weights as high as 80 per cent.
Successful portfolios
Of course, creating a successful range of multi-asset portfolios requires far more than just clever asset allocation modelling. Careful instrument selection across each of the asset classes is of equal importance. Poor manager selection can create unnecessary risk with a portfolio structure that relies on its ability to quantify and manage risk.
