Mar 2, 2021
Low equity multi-asset portfolios aim to provide investors with capital growth by delivering inflation-beating returns, while simultaneously balancing the need for capital preservation. The ideal multi-asset solution allows underlying investors to sleep easy at night, as they have outsourced the asset allocation decision to specialist multi-asset managers. Unfortunately, only a few specialist managers have been able to deliver on these objectives over the last five years and investors are now losing faith in the sector.
Outflows as a result of disappointing recent performance (as illustrated in the performance table below) have been observed. In addition to relative underperformance, the large drawdowns experienced across the sector during the Covid-19 crisis have led many to question the ability of these multi-asset solutions to deliver on their objective to preserve capital, as a few managers were found to have been “swimming naked” when the tide went out in March 2020.
The chart overleaf highlights the netflow trends in the multi-asset sector over the last decade.
Figure 1: Netflow trends in the Multi-Asset sector over 10 years
Source: ASISA 30 September 2020, netflows excluding reinvestments for Retail and Institutional funds, both retail and institutional share classes. Excluding money market, broker funds and FOFs.
The table below highlights the performance of the Ninety One Cautious Managed Fund compared to its low equity peer group, cash and CPI over the last one, three, five and ten year periods:
|Low Equity Multi-Asset||1yr||3yrs||5yrs||10yrs|
|Ninety One Cautious Managed Fund A||8.8%||8.0%||6.4%||8.6%|
|ASISA Low Equity Multi-Asset Category average||5.2%||5.0%||5.4%||7.4%|
|Ninety One Cautious Managed Fund A vs Cash||3.4%||1.4%||-0.6%||2.2%|
|ASISA Low Equity Multi-Asset Category vs Cash||-0.2%||-1.6%||-1.6%||1.0%|
|Cash vs CPI||2.2%||2.7%||2.4%||1.3%|
Past performance is not a reliable indicator of future results, losses may be made.
Source: Morningstar, dates to 31 December 2020, performance figures above are based on lump sum investment, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, fees are not applicable to market indices, where funds have an international allocation this is subject to dividend withholding tax, in South African Rand. *Inception date 01 April 2006.
Annualised performance is the average return per year over the period. Individual investor's performance may vary depending on actual investment dates. Highest and Lowest returns are those achieved during any rolling 12 months over the period specified. Since inception*: Feb-10 23.8% and Feb-09 -6.8%”
It is understandable that investors have been losing faith in the sector as the average fund in the low equity category has underperformed cash over the last one, three and five years. This has not been the case for a limited number of multi-asset low equity funds, including the Ninety One Cautious Managed Fund, which has managed to outperform the peer group and inflation over all the above performance periods and cash over one, three and ten years, net of fees.
The low equity category is the one where most investors are seeking inflation-beating returns while looking to protect capital over the short term (12-24 months). The Covid-19 sell-off period around March 2020 really tested asset managers’ risk management frameworks. We were pleased that the Ninety One Cautious Managed Fund delivered positive absolute returns to the end of March 2020 over the rolling twelve month period, while many peers delivered negative absolute returns. Over the decade the Ninety One Cautious Managed Fund delivered no negative rolling twelve-month return periods, which is a testament to our risk management framework. The maximum drawdown rate for the Fund over last decade was -3.4%, which compares favourably to -8.1% for the sector. 1
While security selection is important, asset allocation is one of the most important decisions in investments and getting this decision wrong has contributed to poor portfolio returns for the average fund in the sector.
The table below highlights the benchmark returns of the key asset classes over the last one, three, five and ten years (green = outperform cash and red = underperform cash):
Source: Ninety One Performance Analytics at 31 December 2020.
Growth assets (i.e. equities and property) need to deliver superior returns relative to income assets (i.e. bonds and cash) in order to compensate investors for the higher risk embedded in these asset classes. Unfortunately, this outcome is not guaranteed, especially when these asset classes are not offering good value. The key performance differentiator for the Ninety One Cautious Managed Fund relative to peers over the last five years has been its large exposure to offshore equities and local bonds, and its low exposure to local equities and local property.
The financial landscape is becoming increasingly complex and multi-asset specialists need to be able to demonstrate they have the asset allocation skills which will not only deliver the return objectives required but also manage risk appropriately.
Investment decisions should not be made looking through the rear-view mirror
It is very dangerous to chase recent performance. There is no guarantee that what has worked the last five years will work for the next five years. If investors were to look back to 2015, local equity and local property had been two of the best performing asset classes for several years and were the cornerstone of most multi-asset portfolios. An assumption that the trend would continue has certainly cost investors dearly over the last five years.
It is too simplistic to conclude that given the poor performance of local equity and local property over the last five years that they will be the winning asset classes over the next five years. Investors need to be skeptical of overly simplistic mean reversion arguments. If asset allocations were this simple, we could rely purely on machines and not require any skill on the part of the portfolio manager.
At Ninety One we believe in a bottom-up approach to asset allocation that is driven by an experienced, globally integrated team, which is philosophically aligned. The team is focused on finding the most attractive risk adjusted absolute return opportunities, rather than chasing relative performance.
Overconfidence in forecasts resulting in risky bet sizes
As the future is never certain, it is important that investors understand probability distributions around forward return expectations, especially when the distribution around the forecasts are quite wide. Research suggests that people are too confident in their own abilities and predictions. As a result, they tend to predict outcome ranges that are too narrow. If they are wrong in those predictions and forecasts are too optimistic, the downside risks to portfolios can be significant, especially when positions were not sized appropriately.
Taking too much risk in the pursuit of returns
It is tempting to add too much risk in the pursuit of returns, however the cost of being wrong can have a devastating impact on portfolio returns. In an era of unprecedented stimulus and “free money” it is always tempting to overstay your welcome. At the height of market euphoria in 2007, Chuck Prince, the CEO of Citibank, famously responded when asked if he was concerned about the risk taking behavior in the market as follows: “when the music stops, in terms of liquidity, things will be complicated, but as long as the music is playing, you’ve got to get up and dance.”2 Needless to say, Chuck lost his job a few months later when the party ended, for failing to manage risk appropriately. Given the swiftness of the equity market recovery since March (less than six months for the S&P500 to recuperate losses and return to pre-Covid levels), it is tempting for market participants to assume that there are no consequences for taking risk as long as we have the central bank ‘put’ in place. While the Covid recovery for the S&P500 has been swift, it took more than five years to recover losses from the Global Financial Crisis and more than seven years to recover losses from the Dot Com crash. As investors, we should never underestimate that the benefits of compounding on long term wealth creation and avoiding large drawdowns are among the key principles of successful asset allocation decisions.
Guard against home bias and unintended consequences if managing local and offshore assets independently
Offshore assets now make up a sizeable portion of multi-asset portfolios. Yet, these assets are often managed independently by third-party managers or independent teams as stand-alone portfolios. When separating the local and offshore asset allocation and asset selection decisions, the combined portfolio may generate a suboptimal risk-return outcome.
By not explicitly recognising and managing the interdependence of various parts of the portfolio, investors are exposed to increased volatility of the overall portfolio as a result of unintended risks. The risk is highest where exposures or investment themes are replicated across different parts of the portfolio, independently. For example, adding more emerging market risk to a multi-asset portfolio may be an attractive investment and a good diversifier for a global investor, but not necessarily for a SA fund. When offshore and onshore assets are too closely correlated, the overall portfolio could have too much exposure to an asset class, equity sector or specific macroeconomic factor. Increasing the overall volatility in a portfolio could result in significant potential downside risk.
We believe that our ability to manage client portfolios in a truly integrated manner is one of our key competitive advantages in South Africa and hence do just this. This has allowed us the ability to guard against home bias or unintended risks from outsourcing parts of the portfolio to independently run teams or third-party managers.
We do not believe that low equity multi-asset portfolios have lost their mojo and think they have an important role to play in financial planning. Investors require inflation-beating returns to grow their capital over time to ensure they do not risk depleting retirement savings too early. At the same time, many investors do not have the luxury of time to recover from meaningful market corrections, so need to ensure capital preservation. A multi-asset portfolio provides an investor with a simple, cost-effective solution of meeting this dual objective. As always, fund selection remains key.
1 Source: Morningstar and Ninety One, performance NAV to NAV net of fees, all period mentioned here as at 31.03.2020.
2 Citigroup chief stays bullish on buy-outs - Financial Times July 10th, 2007.