How to get the right multi-asset mix
Assessing suitability and risk for your clients
Multi-asset funds have grown in popularity over the past decade as more investors seek the benefits that diversification can bring.
However, getting the right mix of assets is not always easy: it is not enough to be merely diversified - the asset mix must reflect the goals and investment needs of the client.
As a result, more advisers and wealth managers are focusing on risk and suitability when it comes to recommending and creating appropriate multi-asset portfolios for their clients.
This guide will provide an overview of how risk and suitability must come to bear on multi-asset fund selection.
CPD: Risk and suitability - getting the right multi-asset mix
How can advisers choose the right multi-asset fund for clients?
The investment industry has been telling advisers and investors for years of the need to diversify and not to simply rely on one or two asset classes – typically equities and fixed income – to generate returns.
The result has been a proliferation of multi-asset funds and ranges which have flooded the retail market in the past few years.
Peter Savage, chartered financial planner at Fairstone NI explains: “They offer the ability to invest in a broad range of assets such as equities, bonds, property, alternatives and cash.
“It also allows investors to invest in a portfolio without having to create the asset allocation themselves through single asset funds.
“This takes away the decision when to rebalance and when to change the asset allocation, as it will be done on their behalf by the portfolio manager.”
Inflows into these types of funds have been growing too as the global macro-economic backdrop has made investors and advisers increasingly nervous about the ability of more traditional assets to meet risk and reward requirements.
There have been concerns some multi-asset offerings are not as diversified as the name suggests though, so how can advisers ensure they are choosing the right fund for their clients which sits within a wider diversified investment portfolio?
Trevor Greetham, head of multi-asset at Royal London Asset Management, suggests: “Risk-rated multi-asset funds can form the core of a client portfolio or represent the entire portfolio. Advisers need to understand a particular fund's objective and how it is set up to deliver it.”
For this, he believes: “The adviser should be clear on the risks and what sort of environment would lead to particularly good and bad outcomes.
“A good performance track record is important but qualitative analysis should play a large part as different funds will work differently from each other.”
The regulator has been firm in setting out its own requirements, as Hugh MacTruong, multi-asset proposition manager at Legal and General Investment Management points out.
“The FCA’s Thematic Review last year, ‘Assessing suitability: Research and due diligence of products and services’ (TR 16-1) addresses this directly,” he explains.
“The report outlines three areas that lead to poor customer outcomes: incorrect risk profiling, cost, and poor quality adviser research. Ensuring that attention is paid to these requirements when recommending a fund should help to deliver better customer outcomes.”
Mr MacTruong adds: “A multi-asset fund that is risk-targeted, pays attention to costs and is clear about what is under the bonnet driving returns can help deliver better investor outcomes – whether it is used as a standalone solution or as part of a core-satellite approach.
“Given that assessing suitability is at the heart of helping the client achieve those objectives, the role of the adviser is crucial.”
Most advisers will start by establishing their clients’ appetite for loss and will produce a risk profile report which should give an indication of how much risk they are willing to take.
“I then discuss their investment objectives, goals and time frame which allows me to determine whether these objectives and goals are achievable within their capacity for loss and risk profile,” says Mr Savage.
“If not, then we need to discuss this further and determine whether the client needs to adjust their goals or accepts they need to look at a different risk profile.”
Typically, the higher the allocation to equities in a portfolio, the higher the risk profile, he adds.
It is also up to advisers to prepare their clients for how a portfolio might behave during different market cycles.
Mr Savage says: “Once this is agreed, I can map the selected risk profile across to a multi-asset fund through their risk rating.”
Finding a multi-asset fund that delivers on its promises can be a challenge – all investors should know past performance is no indication of future returns.
So advisers cannot simply look at how a fund has performed to date and assume this is how it will continue to perform.
Jeremy Leadsom, head of UK wholesale at Aviva Investors, comments: “It is important to understand the sustainability of those characteristics that have made a fund attractive in the past – consistency of income, low volatility, style bias and so on.”
He cautions: “In the current environment of very low realised volatility, it would be quite easy for fund managers to invest in strategies that appear to be low risk, but could prove highly volatile should markets take a turn for the worse.”
Performance in different scenarios
For an adviser seeking a lower volatility fund for a client, it is important that they focus on how the fund might perform in different market regimes.
Mr Leadsom suggests they ask:
– What are the upside and downside risks?
– How does it look in stress tests?
As Nick French, head of UK wealth management at Russell Investments points out: “Advisers can now choose managers whose objectives are similar to those of their clients by selecting managers who are happy to publish their expected returns.
“This, however, must be shown with the risk required to achieve those objectives. There is no point suggesting to a client that a fund could return an annualised 9 per cent without explaining that this could take significant risk and the client would probably experience a volatile journey.”
He continues: “For advisers, choosing the right investment funds is about selecting those managers that are aligned to client outcomes and are prepared to be open and honest about what can be achieved and the journey that will be experienced.”
Mr Leadsom emphasises how important this approach to selecting a multi-asset fund is as the bands within the Mixed Investment sectors allow for a wide dispersion in outcomes.
Chart 1 shows in 2008 there was an almost 50 per cent range between the best and worst performing funds.
“Equally, [as shown in Chart 2] taking on more risk, doesn’t necessarily mean that a client gets a better return,” he adds.
With hundreds of multi-asset funds and fund ranges to choose from, covering every cost, composition, objective, and style possible, one of the most important considerations is whether they are risk profiled or risk targeted, suggests Jason Dewar, head of funds research at Distribution Technology.
A risk targeted range, by definition, operates within a set volatility range with a commitment not to deviate from its given risk profile, he explains. “A risk profiled fund has no such commitment so may over time drift between different risk profiles.
“These funds will typically be listed individually within an appropriate IA Mixed Investment sector, whereas the risk targeted fund ranges will often sit in the Specialist or Unclassified sectors.”
The Investment Association’s decision to launch a Volatility Managed sector from April this year is intended to help find a home for those funds which “target a client’s attitude to risk set out in terms of volatility”, many of which currently sit in the Unclassified sector.
Mr Dewar notes: “While both models are useful, clearly the risk targeted funds offer an important comfort factor, especially if the client does not want or require frequent reviews.”
Ben Willis, head of research at Whitechurch Securities, believes there will be an increasing number of multi-asset funds focusing on risk adjusted returns.
“It used to be that there would be a cautious, balanced and aggressive offering (there still are) but this wasn’t quite enough and now these can be independently risk rated.”
He cites Distribution Technology and its Dynamic Planner risk profiler, which puts funds through its independent risk analysis to receive a rating which is mapped to the outcomes of its client risk profiler.
What are useful models?
So are those multi-asset ranges with differing risk profiles a useful model?
Mr Leadsom notes risk-targeted funds are not the only way to deliver client outcomes.
“But they are useful, in that they seek to deliver an investment outcome, while being aligned to a client’s risk appetite,” he says.
“Equally, from an adviser perspective, it allows them to establish the client’s attitude to risk and invest them in a fund whose risk should remain below the pre-determined upper limit over time.
“This addresses the question of ongoing suitability, and allows advisers to focus on the key issues of managing the broader client relationship, rather than focusing on investment.”
The relationship between an adviser and their clients is vital to ensuring investors are only exposed to multi-asset products which suit their needs and are not exposing them to any undue risk.
It is also critical the investor is made to understand the limitations of a multi-asset portfolio, whether risk targeted or risk profile.
For some, a multi-asset fund will not be suitable at all within their portfolio and they will be better allocating to different asset classes and regions via other types of investment vehicles.
Mr Willis acknowledges the process of advising can be time consuming but confirms that is why fees are charged by the adviser.
“Arguably the most important part is the ongoing review. If the fund is not behaving or delivering as it should, then the adviser has to be able to act quickly, decisively and have alternative solutions to hand.
“Knowing your client, their objective and how much investment risk they are prepared to take, is at the cornerstone of all investment advice.”
This will be helped by multi-asset providers continuing to recognise the changing needs of investors and offering products which clearly and transparently meet those risk and suitability requirements.
Ellie Duncan is deputy content editor for FTAdviser
House view from Royal London Asset Management
How should advisers choose the right fund for their clients, which delivers on its promises and sits within a wider, diversified investment portfolio?
Risk-rated multi asset funds can either form the core of a client portfolio or represent the entire portfolio. Advisers need to understand a particular fund's objective and how it is set up and managed to deliver it over the stated time horizon, within the agreed risk parameters.
The adviser should be clear on the precise risks of the fund, and on what sort of environment would lead to particularly good and bad outcomes.
A good performance track record is important, but qualitative analysis should play a large part as different funds will behave differently from each other.
Our Global Multi Asset Portfolios (GMAPs) combine diversified asset classes in varying proportions. Diversification is a vital tool for risk management, as it means that within our portfolios, we hold assets that tend to do well in contrasting market environments.
This enables us to take decisive asset allocation decisions according to our market views, while retaining holdings in other asset classes to guard against the ‘unexpected’.
While we monitor risk in our portfolios on a daily basis, we do not target specific risk levels in the manner that some managers do. We move in and out of asset classes primarily according to where we think it is best to be invested.
We look at tracking error and at the distance from each portfolio’s central benchmark position with the aim of ensuring that we do not over- or undershoot too far, but we prefer not to let the tail wag the dog in terms of risk in our portfolio management.
How should advisers conduct suitability reports to ascertain clients' risk and reward and apply that to choosing a multi asset fund?
Advisers need to have a structured process that assesses their clients' time horizon, attitude to short-term losses and degree of investment sophistication.
It is also important to have a realistic target for the level of returns that the client should aim to achieve, and to have a clear picture of how much risk the client is both willing and able to take.
It should be easy for a client to understand the multi asset fund in which they are invested, which will be partly a function of their own level of investment knowledge, and partly of the complexity of the fund itself, so simplicity and transparency are very important.
There is a very broad variety of multi-asset funds in the market. When creating a multi-asset product, it is possible to construct a range of portfolios to suit different risk appetites by implementing even just marginal changes in asset allocation between higher risk and ‘safe haven’ assets, and to move between different levels of risk in a graded, methodical way.
At RLAM, we look at the long-term risks of different asset classes, and we have designed our benchmarks based on this analysis - across the risk spectrum from conservative bond portfolios to funds with a high proportion of equities.