CAPE TOWN – At the end of 2005 there were only 220 domestic multi-asset unit trusts in South Africa. These funds had R68 billion in assets under management, which was just 17% of the total invested in local collective investment schemes.
Today, not quite ten years later, there are 613 South African multi-asset funds, with assets under management of over R800 billion. Their market share is now 50%.
This growth in multi-asset mandates has been one of the most significant developments in the history of the local unit trust industry. It could be argued that it has fundamentally changed the primary function of asset managers.
In the past, fund managers were predominantly stock pickers. Most of the money that went into unit trusts was invested in general equity funds that tried to maximise returns from the stock market.
While there is still a large element of this, it is no longer what investors demand most. The skill that they are most interested in these days is asset allocation.
“Especially in the current environment where we have had this big run up in equity markets post the financial crisis, multi-asset funds are definitely becoming more popular,” says Nadir Thokan, investment analyst at 27Four Investment Managers. “Investors are seeking to diversify their sources of risk and return.”
Put another way, investors have come to a better understanding of the benefits of using more than one asset class.
Three things investors want
Anthony Gillham, multi-asset portfolio manager at Old Mutual Global Investors, says that their customers consistently ask his team to deliver three things in terms of how their portfolios behave. They want consistent investment performance, downside cushioning, and diversification.
“Consistency in performance is about the smoothness of the ride,” Gillham explains. “It is not just about total returns, but the manner in which those returns are achieved.”
Blending together asset classes that will perform differently at different stages of the cycle is therefore essential. The big benefit to the investor is that this takes out the worst of the volatility and discourages the wealth-destroying behaviour of buying at the highs and selling at the lows.
The second key thing multi-asset funds need to deliver is protection against big draw downs in the market.
“It is incumbent on managers to try to mitigate the worst of market downturns,” says Gillham. “That means being sensitive to what is going on in markets and taking money off the table when the risks are high.”
While investors might rejoice when they see their portfolios outpacing the market when times are good, the most important time to seek out-performance is actually when markets go down. Minimising losses can have a major long term impact.
Consider, for instance, that if your portfolio loses 50%, it then has to gain 100% just to get back to where it was. If it only lost 15%, however, the growth required to recover would be just 18%.
Restricting the downside therefore not only means that returns are smoother, but you also don’t have to take as much risk on the way up again.
The third key component in multi-asset portfolios is diversification. This might sound obvious, but there is more to good diversification than just tossing different asset classes together.
“Diversification is about the ability to produce low-correlated returns,” Gillham explains. “That means a broad spread of assets, a range of different strategies, and also diversification in terms of position sizes. I don’t want a fund to be driven by just one or two economic views. I want lots of small active positions because that is going to help me produce the most consistent performance.”
Active asset allocation
While some investors might be happy to manage their own asset allocation decisions, the complexity of blending assets and styles together in the right mix is something many prefer to leave to a professional manager. That is why multi-asset funds have become so popular.
“The ultimate value added by good asset allocation decisions dwarfs the alpha that can be delivered in the underlying building blocks,” argues chief investment officer at Coronation, Karl Leinberger. “This is the big call and you need to get it right. I think it makes sense to leave the asset allocation decision to someone who has the appropriate skill set and then to hold them accountable for those decisions.”
He believes that this will become particularly important in the coming years in which real returns are likely to be much lower than they have been over the last decade and a half.
“Active managers are going to get some calls right and some wrong,” says Leinberger. “But in these unique times, I would rather have a team with skill and experience making bold and decisive decisions on my behalf.”
In essence, good asset allocators are most valuable in uncertain markets. That is when their abilities are most tested, but also when they are most needed.
“Diversification is the only free lunch you get in investing,” Thokan says. “You can achieve significant risk reduction by including more than one asset class without reducing your returns all that much.”