UK: Classification Of Multi-Asset Funds

Last Updated: 24 October 2018
Article by Andrew Cheung and Shan Gao

Despite the rapid growth of the market and the increasing institutional adoption of multi-asset strategies, there is a blurring of terminology, which causes difficulties at times in terms of classification. There are many different types of strategies that might be labelled as multi-asset, encompassing a wide range of risk/return objectives, and a variety of approaches to achieve those objectives. Some are based on quantitative or systematic processes, while others are qualitative in nature.

The term DGF seems to cover a variety of approaches and there are no established boundaries of what the term "DGF" represents. We have seen strategies in the DGF universe ranging from absolute return strategies to vehicles using dynamic asset allocation of various shades. Choosing the right strategy for an investor's specific needs is important.

Several participants in our survey raised this lack of a common language and definition as a concern and a possible source of confusion amongst institutional investors. In the following table, we summarise the spectrum of multi-asset strategies and the naming conventions that are used elsewhere in this report.

  • Passive/Strategic Allocation (or Balanced) Funds: These funds allocate around broad asset allocation limits - often using passive investment to gain exposure to a diversified set of traditional return sources and alternative return sources, which have a long term strategic benchmark (passively managed with a static asset allocation or a set of investment constraints);
  • Dynamic Asset Allocation Funds: These funds are not required to hold specific asset classes due to the presence of a strategic benchmark and can adopt tactical/active asset allocation to invest in a broad array of growth assets;
  • Absolute Return Funds: These funds target the delivery of a positive return in all market conditions through long and short paired positions. These strategies prioritise the avoidance of negative returns and are less dependent on the direction of the market;
  • Risk-based Allocation Funds (incl. Risk Parity Funds): These funds provide a risk-diversified or risk-balanced portfolio of exposures to a broad range of asset classes. They allocate assets across investment strategies based on individual risk budgeting for each asset class. They typically target a specific risk level.

Apart from the Balanced Funds, all of the other strategies above claim the DGF label, which is one of the reasons for DGF's ubiquity. 

We observe that some of the dynamic asset allocation fund managers have flexibility to tilt the portfolio significantly from the strategic asset allocation, often with a minimum equity exposure of around 30% of the whole portfolio. This group has more variation in performance between its constituent managers, though this flexibility can allow managers to be better placed to deliver an absolute return.

Another large group of DGFs comes under what we define as 'Absolute Return Funds'. For these strategies, the focus on risk allocation (rather than asset allocation) and tighter risk management form an integral part of the investment process.

TABLE 1: multi-asset strategies classification


 

Asset-based allocation

Risk-based allocation

Passive / Strategic Allocation
(or Balanced) Funds

Dynamic Asset Allocation Funds

Absolute Return Funds

Risk-based Allocation Funds
(incl. Risk Parity Funds)

Asset Allocation Approach

Relative static capital asset allocation

Dynamic capital asset allocation

Risk-based allocation approach

Risk-based allocation approach

Long / Short

Long only

Mostly long-only

Long-short

Long-only

Typical range Equity Investments

30%-60%

10%-60%

N/A, low equity beta

N/A, low equity beta

Annualised Volatility1

High (between 4.2% and 8.3%, average 6.2%)

Medium (between 3.7% and 8.8%, average 5.8%)

Low (between 1.5% and 5.6%, average 4.0%)

Medium (between 3.1% and 8.1%, average 5.7%)

Correlation to Equity market2

High (between 0.49 and 0.99, average 0.89)

Medium (between 0.57 and 0.97, average 0.75)

Low (between 0.29 and 0.91, average 0.66)

Medium (between 0.40 and 0.96, average 0.70)

Drawdown3

Medium expected drawdowns (between -11.9% and -3.1%, average -7.2%)

Medium expected drawdowns (between -12.8% and -4.0%, average -7.7%)

Small expected drawdowns (between -7.4% and -3.0%, average -5.0%)

Large expected drawdowns (between -14.7% and -2.8%, average -8.5%)

Average Information Ratio4

0.73

0.47

0.04

0.47

AUM5

16% of the market

22% of the market

41% of the market

21% of the market

Source: MJ Hudson Allenbridge, Camradata and Bloomberg

1 Measured as 5-year annualised volatility as of Q2 2018.

2 Measured as 5-year correlation coefficient with MSCI ACWI Gross GBP Index as of Q2 2018.

3 Measured as 5-year maximum drawdown as of Q2 2018.

4 Average information ratio over the past five years relative to ICE LIBOR GBP 1 Month + 3% as of Q2 2018.

5 Estimated based on the submission of DGF manager responses to MJHudsonIQ with Camradata and Bloomberg used as a supplementary sources.

Unlike Balanced Funds, the rest of the strategies are not working to an external static benchmark. Instead, they share similar return targets over the longer term, typically CPI or cash plus objectives, which have traditionally been used as long-term global equity annual return targets.  Additionally, DGFs have generally reduced realised volatility compared to that of a pure equity portfolio, typically by between a third and a half, therefore accomplishing their risk reduction objectives. Hence, with DGFs, the focus is on total fund return relative to stated return and volatility objectives as opposed to performance relative to a universal benchmark. Additionally, some of the DGFs blend more than one strategy in one portfolio, for example, a mixture of strategic, dynamic, and low equity beta strategies makes it even more difficult to assess the performance of the overall DGF market.

Some of the above categories venture into the territory of global macro hedge funds and alternative risk premia funds, which similarly employ a range of long and short relative value positions while utilising options and other derivatives. We have seen increased competition between DGFs and other funds going forward. The battle is likely to be fought in the crucial areas of managers' skill, fees, capacity, transparency and client servicing, though the real beneficiaries should be pension schemes and other investors who will be able to access more efficient investment strategies at lower costs.

In the near future, we expect to see a number of multi-asset approaches existing simultaneously. We welcome any further strategy developments and believe that going forward diversification by approach will become as relevant as diversification by asset class.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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