In 2016, MJ Hudson Allenbridge published a special report titled "Diversified Growth Funds – doing a good job?"1. The paper provided a brief overview on the diversified growth fund ("DGF") market at the time, considered key advantages of DGF funds and proposed an approach to selecting a suitable DGF manager from both qualitative and quantitative perspectives.
In an effort to update investors with the current products available, market trends, and challenges in this space, MJ Hudson Allenbridge decided to run this second edition of the market review in 2018, supported by a web-based survey with the participation of 37 asset managers, covering 91 institutional multi-asset funds, of which 81% (74) are DGFs. The survey was conducted during Q1 2018 via our proprietary online due diligence platform, MJHudsonIQ. In this report, we have looked at passive and active multi-asset strategies and have excluded any alternative risk premia2, multi-asset income and credit funds. We consider DGFs as an active multi-asset strategy, which comprises Risk-based Allocation Funds, Dynamic Asset Allocation Funds and Absolute Return Funds. Over the past few years, the rise of multi-asset strategies, especially DGFs, has been a significant trend in the UK institutional market. At MJ Hudson Allenbridge, we have seen some interest among our institutional clients, evidenced by some manager searches in the space over the last two years. Institutional adoption of the strategy has become widespread, albeit the recent disappointing returns have made investors sceptical; we have seen an increasing number of investment managers offering these products in the last few years.
SIZE AND SCOPE OF THE MARKET
- We estimate around £400 billion of assets to be invested in multi-asset funds as of the date of the survey. Our survey covers approximately 75% of the managers in the market in terms of assets under management ("AuM");
- Around one-third of asset managers witnessed asset growth in excess of 100% in the last two years (the time of our previous market review). Only two out of the thirty-seven respondents experienced significant declines in AuM (that is, 10% or greater) over the period, mainly due to dissatisfaction with performance and corporate restructuring;
- The top five multi-asset managers by AuM held 52% of market share as of the date of the survey;
- 53% of the surveyed managers do not place any capacity limits on their funds; the rest have either a hard limit or a soft limit, the latter, which can be readjusted depending on market dynamics.
- Corporate pension funds are the largest source of assets for multi-asset managers;
- Multi-asset managers list Local Government Pension Schemes (LGPS) as the second largest source of assets. Other important sources were ultra-high net worth individuals, Family Offices, Endowments and Charities.
BENEFITS AND IMPEDIMENTS
- Nearly all of the managers cited that investors were investing in multi-asset funds due to the ability to invest in multiple asset classes via a single vehicle and also to help reduce overall portfolio volatility;
- Managers cited other benefits of investing in multi-asset funds included operational ease, lower fees and fewer governance resources relative to creating bespoke allocations to risk assets;
- DGFs were identified by managers as an attractive product for investors who struggled to embrace a dynamic asset allocation model, especially for smaller institutional and individual investors who may lack resources;
- Most managers stated that one of the key issues they faced is that DGFs lacked clarity in terms of standard definition, constituents and lack of recognised universal performance benchmarks. Managers cited these as the main impediment that could hinder both prospective and existing investors in further investing into the strategy;
- Managers stated that DGFs that did not have income share classes (approximately half of overall multi-asset funds as of the date of the survey) were also considered as an impediment for prospective institutional investors, given that the latter find income distribution attractive for managing their pension obligations.
- Increasing scrutiny on fees from investors and increased transparency on overall charges have created a downward pressure on fees in line with what has been observed in the broader asset management industry. Our survey found of the 91 funds we track, 17 of them have lowered their management fees by between 5 to 35 bps in the last three years;
- The majority of the multi-asset funds (78%) have ongoing charges of less than 1% with the median management fee being 55 bps across the 91 funds that we track; Additionally, fee pressure is present, partly because some of the better performing multi-asset funds are passive/balanced funds which have lower fees;
- Whilst uncommon amongst multi-asset funds, there are a minority of managers charging performance fees.
- Managers were uncertain or expected no change on the overall costs with the introduction of MiFID II1;
- Managers have been forced to reassess the quantity of research they source from investment banks or brokers. We see some managers (18%) looking to decrease their reliance on external research providers and aim to increase their in-house research capabilities.
Market Performance Summary:
- Across the 91 multi-asset funds we are tracking, many share similar investment and volatility objectives, but employ different strategies;
- In terms of the number of funds, the largest portion of market players (c. 35%) are Dynamic Asset Allocation funds, which 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 range of growth assets;
- However, in terms of AuM, the largest percentage of the assets are invested in Absolute Return strategies (c. 40% of overall market AuM), which aim to deliver a positive return in all market conditions through holding both long and short positions;
- We have seen growth in Risk-Diversified or Risk-Balanced strategies (c. 20% of overall market AuM), which allocate assets across investment strategies based on individual risk budgeting for each asset class/holding. They typically target a specific risk level;
- Passive/Strategic allocation funds (or balanced funds) account for about 16% of the overall market AuM; these funds allocate around broad asset allocation limits.
- Most multi-asset funds target outperformance of inflation/cash plus 3%-5% over the medium term (i.e. three to five years). As of Q2 2018, two thirds of the funds (65%) had achieved their stated investment target respectively, averaging a 3-year annualised absolute return of 5.6%;
- More recently, multi-asset funds overall have produced disappointing performance, posting an average 1-year return of 4.1% and YTD return of -0.3% as of Q2 2018;
- Over the past three years, the passive/strategic allocation funds have posted an average annual return of 9.0% outperforming the other three DGF categories namely Absolute Return, Dynamic Asset Allocation, and Risk-Balanced Allocation strategies;
- The DGF universe is not homogeneous. Actual performance dispersion across DGF funds has been significant. Over the same 3-year period, the dynamic asset allocation and risk-based allocation funds returned 5.5% and 5.6% respectively, while the absolute return strategies have been the worst performer overall, generating 3.1% p.a. on average over the same period;
- Notably, in the last two years, absolute return DGFs have underperformed the overall multi-asset market (4.2% vs 6.9% p.a. on average), as these managers have struggled to generate alpha;
- Due to the large performance dispersion, it is important to ascertain the type of multi-asset funds in which investors are investing (namely, passive or active, long only or long-short, capital asset allocation or risk based allocation etc.), what the correlation to equities and bonds is, and to seek evidence of appropriate skill where managers claim to add value e.g. asset allocation/manager selection etc.
- The broad market consensus seems to indicate that we are approaching the end of the interest rate cycle and the end of the benign environment for risky assets (equities in particular), and as such, the ensuing market impact and volatility could make it difficult for risky assets to achieve returns that exceed inflation or cash. This could provide opportunities for multi-asset funds, especially DGFs to outperform other strategies, provided that managers consider a wider range of return sources, enabling a higher degree of diversification.
1 MJ Hudson Allenbridge, "Diversified Growth Funds – doing a good job?", http://www.allenbridge.com/wp-content/uploads/2016/02/Perspectives-DGF-FINAL-2-Feb-2016.pdf
2 MJ Hudson Allenbridge, "Systematic Factor Market Review Q4 2017", https://www.mjhudson.com/assets-systematic-strategies-doubled-last-three-years-according-mj-hudson-allenbridge-survey/
MiFID II does not allow research to be bundled together and a separate account must be used to purchase these services.
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.