February correction called a reminder that high returns are over
February's global equity market correction could boost demand among Asia-Pacific investors for relatively complex multiasset strategies, market veterans said.
With the strong returns from traditional equity and fixed-income beta following the financial crisis "unlikely to be replicated" going forward, asset owners increasingly are focusing on dynamic and tactical asset allocation, and other return streams to cope with the less generous environment they see coming now, said Simon Coxeter, a Singapore-based principal with Mercer's hedge fund and equity boutiques, responsible for evaluating multiasset and equity strategies.
Asset owners are looking for managers "who can bring a lot more tools to the table to achieve investment objectives," and unlock additional sources of return by being more dynamic, agreed Erik Knutzen, chief investment officer, multiasset class portfolios with New York-based Neuberger Berman.
Nicholas Hadow, chairman of the Investment Management Association of Singapore, at a late January briefing on the outlook for the industry in 2018, called multiasset mandates the biggest opportunity money managers in the region anticipate this year.
An IMAS survey of more than 100 money managers with operations in Singapore showed 54% of respondents citing multiasset strategies as the coming year's "top strategy of choice," besting the runner-up — ESG-focused strategies — by more than 13 percentage points.
That promises a continuation of the trend seen during the previous year. Broadridge Financial Solutions, a New York-based fintech provider that tracks institutional allocations globally, found managers reporting roughly $8 billion in multiasset strategy inflows from Asia-Pacific investors for the six months ended Sept. 30, said Yoon Ng, Broadridge's Singapore-based director, Asia global market intelligence.
Those inflows ended a seven-quarter stretch of net outflows, she said.
More recent signs of accelerating demand include a request for proposals from Manila's Government Service Insurance System, the $20 billion pension fund for Philippine government employees, issued in November for two multiasset managers to oversee roughly $400 million each. A GSIS spokesman couldn't immediately be reached for comment.
Market veterans said the bulk of flows from Asia-Pacific investors continue to head to more traditional multiasset strategies that avoid the use of esoteric instruments deploying derivatives or leverage.
Mercer has long urged asset owners to consider "idiosyncratic" strategies less reliant on traditional beta return streams, and Mr. Coxeter called the recent global equity market sell-off — sparked by Wall Street's stumble in February — an illustration of the vulnerabilities Mercer is looking to help clients address.
Fears prompt sale
Fears of inflation prompted investors to sell both bonds and stocks, a "synchronized" decline that left investors in "core" traditional multiasset strategies getting no diversification benefits, said Mr. Coxeter.
That in turn could lead investors not comfortable considering extensive use of derivatives to look again at more dynamic, diversified strategies less reliant on traditional betas, he suggested.
For such strategies, constructing a portfolio diversified by risk factors remains the more important goal, rather than trying to actively adjust allocations along the way, said Ricky Chau, a Hong Kong-based vice president and multiasset portfolio manager with Franklin Templeton (BEN) Investments (BEN) (Asia) Ltd.
Some managers say that transition to more sophisticated strategies is already underway. "There's been a significant shift away from very traditional multiasset strategies to more systematic-based strategies," constructed to achieve absolute-return targets, said Nicolaas Marais, president, multiasset-class solutions, research and product management, with San Francisco-based Wells Fargo Asset Management.
Managers of less traditional multiasset strategies contend their lower exposure to core equity and bond market beta left them well positioned for the recent global equity sell-off and better positioned to maintain exposure to growth assets while controlling downside risks.
Andrew Sneddon, a Sydney-based managing director and senior portfolio manager of multiasset strategies with Russell Investments, said his portfolios started 2018 with their lowest allocations to equities in five years, having shifted allocations into commodities and call options structured to "give us a considerable amount of the upside but with the downside, left tail more protected."
Mr. Sneddon, who oversees $15 billion in multiasset strategies, said his firm continues to see a "strong uptick in interest" as more investors conclude they're unlikely in coming years to be rewarded as consistently from static exposures to stocks and bonds as they've been in the period following the financial crisis.
Neuberger's Mr. Knutzen said his firm's $5.5 billion book of multiasset business — roughly half spread across five or six strategic partnerships — has likewise benefited from a dynamic approach to risk.
Mr. Knutzen said his team, anticipating that the absence of volatility in 2017 wouldn't continue this year, "took the opportunity at the end of January to trim our equity exposures," even though they had no inkling the market would be up 7% over the first three weeks and then down 10% in the following week and a half.
The Neuberger team likewise employs options to cope with equity-related risks, but as a seller of puts rather than a buyer of calls.
The costs an asset owner faces in using puts to protect the value of its equity holdings is roughly 1.5% per month, or an annual cost of 18%, for an asset class expected to generate annual returns of 9%, noted Mr. Knutzen. At that price, "I'd rather sell that insurance" than buy it, he said, adding Neuberger's "systematic writing of puts" brings the firm a return of roughly 9% a year, roughly equivalent to what the market is expected to yield, with a fraction of the downside.
Mercer's Mr. Coxeter, while declining to provide details, said his firm has identified 10 to 15 idiosyncratic multiasset managers worth examining. But he noted the number of firms busy building up their multiasset teams now is growing.
Wells Fargo is one. Mr. Marais, who joined Wells Fargo just over a year ago, said his team has grown to 24 from just five when he started. He said the multiasset business, accounting for $28 billion of the firm's $504 billion in assets under management as of mid-January, represents the "spear point" of the company, "bringing all the moving parts together" to meet client needs.
Some market veterans, however, say traditional multiasset strategies are likely to remain the focus of client demand going forward.
Leon Goldfeld, a Hong Kong-based portfolio manager with J.P. Morgan Asset Management (JPM)'s multiasset solutions team, said "idiosyncratic" strategies, while certainly part of his firm's offering, account for only $10 billion of a $250 billion global book of multiasset business.
Great when it works, but ...
That partly reflects the elevated reliance on skill — or chance — in managing idiosyncratic strategies: "great when it works, not as good when it doesn't work," he said.
Instead, Mr. Goldfeld said he finds asset owners willing to take a long-term view on the returns offered by traditional sources of beta — confident those returns will be attractive over investment cycles even if markets can't be expected to pay out "every day, every week, every month."
Mr. Goldfeld figures clients should expect roughly 80% of returns from traditional beta exposures and the remainder from dynamic allocation decisions. He said J.P. Morgan's strategies were positioned for the recent sell-off by calibrating the size of their equity bets in line with anticipated levels of volatility significantly higher than the actual level prevailing for the past year through January.
Meanwhile, even if market veterans widely anticipate tougher times by 2020, or possibly 2019, there is broad agreement that February's spike in volatility is unlikely to derail supportive market conditions anytime soon.
Both Mr. Sneddon and Mr. Knutzen said they're looking now to add allocations to equities.