Poor markets to test multiasset managers

Multiasset strategies could face growing scrutiny in coming years as the prospect of stingy market gains leaves institutional investors relying more on managers' asset allocation skills to pursue their targeted returns.

Recent research by investment consultants Willis Towers Watson PLC and Cambridge Associates LLC suggests such skill is an all-too-rare commodity.

That proposition has yet to be put to the test, as strong equity and fixed-income market gains since the global financial crisis generally helped managers hit their marks — often set as LIBOR or inflation plus 2% or 3% for more defensive strategies, and LIBOR or inflation plus 4% to 5% for more aggressive strategies.

That could be changing now, with markets over the past year becoming less generous and more volatile, even as net flows to multiasset managers have remained strong in Europe and the Asia-Pacific region.

According to London-based consulting and research firm Spence Johnson's Institutional Money in Motion database, net flows to multiasset strategies for the three years through Dec. 31 came to roughly $37 billion for clients across Europe, the Middle East and Africa, and $10 billion for Asia-Pacific clients.

The focus of investors now is shifting to how managers can achieve risk-and-return objectives in a market environment where the “ability to generate alpha” — via dynamic asset allocation, active positioning within asset classes and relative-value trades — could become more important, said Laura Rieber, Singapore-based senior investment director with Cambridge Associates Asia, in an e-mail.

Multiasset veterans report the same change.

Investors are paying more attention to “what our value-add is,” and active allocation skills, including dynamic and tactical asset allocation, have become an “increasingly important part of the conversation,” said Garth Taljard, head of multiasset management for London-based Schroder Investment Management Ltd.'s $110 billion multiasset business.

Growing interest in “asset allocation alpha” — to achieve “required returns ... in a low nominal return world” — is what's driving institutional investors to embrace multiasset now, agreed Michael Kelly, global head of New York-based PineBridge Investments' $13.4 billion multiasset business.

Mr. Taljard pointed to the $562 million Japan Diversified Growth Fund as one example of dynamic allocation shifts helping Schroder's multiasset strategy achieve its objectives of positive absolute returns and downside protection during the first quarter of 2016, which saw key equity benchmarks in the U.S. and Japan plunge as much as 11% and 21%, respectively. Keying on a destabilizing plunge in Chinese stocks, “we reduced our equity exposure in the first week of January to around 10%,” from 15%, which — along with a decision to buy energy stocks as oil prices stabilized — helped the fund post a 1.1% gain for the quarter, with a maximum drawdown of 1.4% along the way.

Jeffrey L. Knight, global head of investment solutions and co-head of global asset allocation with Boston-based Columbia Threadneedle Investments, said the risk-parity structure of his $1.2 billion Columbia Adaptive Risk Allocation strategy and a timely move to close the fund's underweight position in commodities helped limit its maximum drawdown during the volatile start of 2016 to roughly 3%, and post a gross first-half return of 8%.

Still, some gatekeepers warn that client dreams of active alpha from their multiasset managers could easily prove elusive.

“Our view is that (managers) will find it challenging to achieve their performance objectives if (as is widely expected) the future is an environment of depressed and volatile returns,” said a Willis Towers Watson report in March that concluded that dynamic and tactical asset allocation more often than not detracted from manager returns.

Meanwhile, even as the multiasset strategies of firms have garnered strong net inflows, for the most part their returns have trailed a traditional 60/40 mix of equities and fixed income — in part, reflecting central bank policies focused on buoying risk assets.

“It's been difficult to add value in dynamic/tactical asset allocation in an environment where relatively expensive assets (such as sovereign bonds and U.S. equities) continue to appreciate,” Ms. Rieber said.

In recent years, “if you invested away from 60% U.S. equity/40% U.S. investment-grade bonds, you lost,” said Andrew Sawyer, chief investment officer of the $12.2 billion Maine Public Employees Retirement System, Augusta, in an e-mail.

The effective safety net created by central banks has limited the ability of multiasset managers, including State Street Global Advisors, to exploit the historic relationship between high volatility and stock market sell-offs, leaving some strategy results “below our expectations,” said Thomas Poullaouec, a Hong Kong-based managing director with SSgA, and head of strategy and research-Asia-Pacific for the firm's investment solutions group. He wouldn't elaborate.

Mr. Poullaouec said his team is researching whether such changes to historic relationships are likely to prove a short-term phenomenon or something more fundamental.

Monetary policy has weighed on a multiasset manager universe built, in part, on the precept that diversification is the “only free lunch,” said Mr. Sawyer, adding that his belief that those managers can make longer-term contributions to investment portfolios is predicated on expectations that “somehow, sometime central banks' policies will revert to more normal circumstances.” As of the June 30, 2015, close of Maine's previous fiscal year, the pension fund reported allocations to two multiasset firms, with $317 million managed by Boston-based Grantham, Mayo, Van Otterloo LLC and $274 million managed by Boston-based Windham Capital Management LLC.

A reasonable forecast now for a 60/40 portfolio's return is an annualized 6% over the coming decade, down from 8% historically, predicted James Elliot, a London-based managing director with J.P. Morgan Asset Management and chief investment officer of its multiasset solutions team's international business. A period of lackluster returns that could stretch several years and account for the bulk of that coming decade's shortfall might have already begun, he said.

Assets in JPMAM's multiasset solutions business grew by $13 billion, to $173 billion, in the 10 months through March 31, including billions of dollars of retail flows to a multiasset macro opportunities fund that reached its three-year track record in August and, on the institutional side, an $800 million allocation from Taiwan's $104 billion Bureau of Labor Funds, Taipei. Mr. Elliot declined to discuss specific clients.

In the current low-return environment, institutional investors content to continue “straitjacketing themselves” to their strategic asset mixes will find the gap between their assets and their liabilities growing ever wider, predicted PineBridge's Mr. Kelly. Assets will flow to managers that can exhibit skill in moving “opportunistically between markets” — a function of asset allocation alpha, which is almost “a lost art,” he said.

Others predict a similar future.

“I am convinced that ... a large proportion of the assets which have flowed into traditional strategies will migrate to multiasset strategies,” as an antidote for an “allocation decision” that remains “completely undiversified” for the vast majority of institutional investors globally, said Pranay Gupta, head of multiasset strategies for Fullerton Fund Management, an affiliate of Singapore-based sovereign wealth fund Temasek Holdings.

It's an industry byword that asset allocation accounts for 80% or more of a portfolio's return, but the vast bulk of institutional investors will spend 80% of their time and effort hiring 20 different kinds of managers to diversify security selection risk, Mr. Gupta said. Increasingly, the hiring of multiasset managers will be seen as a way to diversify that allocation decision, and as more assets — and as a consequence, revenues — flow to those managers, “part of the skill that is currently being deployed in security selection, will be deployed in devising new ways of doing allocation” — a field rich with problems to solve, he said.

Multiasset veterans predict the current market could help winnow the multiasset universe's fast-expanding list of competitors. Markets like those of the past 12 to 18 months have a way of separating out “those managers that can navigate successfully and those that can't,” noted Schroder's Mr. Taljard. n