Multi-asset funds: it’s all about design

• Multi-asset index funds are a useful tool for all or a core of DIY investors’ portfolios
• Consideration of investment philosophy and process is key
• A plain vanilla 60/40 GBP index can help comparison

 
Multi-asset index funds are a powerful and straightforward way for DIY investors to create a multi-asset, diversified and low-cost core holding within a portfolio.

How much should I have in my core?
For index investors not wanting to worry about creating and managing their own asset allocation, these funds can provide a one-stop shop and receive a 100% allocation.
For investors who enjoy picking their own stocks or funds, these funds can provide a helpful core exposure.  The extent to which multi-asset funds make up a core is up to the investor as a preference, and obviously impacts the similarity of portfolio performance to a multi-asset fund.
Investors who want the bulk of their risk-return characteristics to be self-selected should consider a lower allocation to a multi-asset fund core, for example 20-40%.
Investors who want the bulk of their risk-return characteristics to be consistent with the chosen multi-asset fund should consider a higher allocation to that core, for example 60-80%.  Self-selected single asset class investments would thereby represent satellite holdings.

Selecting a risk profile
Multi-asset funds typically come in “suites” with 3 to 5 versions to choose from based on risk profile.  Risk profile can be defined by percentage allocation to equities, so investors can select a risk-return profile that is consistent with their objectives.

How do they differ?
Multi-asset index funds will differ in the following ways in terms of philosophy and process:

• Strategic asset allocation: what is it and why.  Some multi-asset index funds use proprietary models, some are linked to third-party research firms.  There are no right answers here, but design preferences around issues such as home equity bias and construction of the bond portfolios are considerations that investors should be comfortable with.
• Static vs dynamic: for some funds, the mix between equities and bonds never changes.  We call this a “static allocation” approach.  Over the very long-term that’s not a problem.  But for investors with short- to medium-term (3 to 20 years in my view) time horizons, it makes sense to adapt to changing market and economic conditions.  We call this a “dynamic allocation” approach.  Understanding the extent, direction and process for dynamic allocation changes is key.
• Open vs closed architecture: some multi-asset funds exclusively use building block funds from their own stable.  We call these closed architecture.  This means that the allocation is constrained by the availability of their own product sets.  Other funds are open architecture.  This means they use whole of market index funds from third party asset managers.  Our preference is for the latter from a counterparty and competitive perspective.

Does it make sense to hold more than one multi-asset fund?
Not really.  Multi-asset funds of the same given risk profile (as defined by % equity allocation) will have similar risk-return characteristics.  The building block index funds they use will mean similar underlying equity/bond exposures.  They are all incredibly well diversified.  Having multiple multi-asset index funds just reduces economies of scale, introduces higher frictional dealing costs, and blurs transparency around asset allocation.  Investors should therefore select a multi-asset fund whose objectives and investment process resonates best and where value for money is keenest.

Comparing multi-asset funds
The IA Mixed Investment Sectors are peer groups of multi-asset funds.
There are four relevant “risk profiled” sectors for multi-asset funds (Target Volatility and Target Absolute Return funds are treated separately.)

• IA Mixed Investment 0-35% Shares
• IA Mixed Investment 20-60% Shares
• IA Mixed Investment 40-85% Shares
• IA Flexible Investment

These sector categorisations are overlapping which is problematic, as a fund with a 60% equity allocation could theoretically fit in to 3 of these sectors.  This is why many “risk profiled” multi-asset funds are classified as “Uncategorised”, which is as unhelpful.
However these remain popular peer groups for comparative purposes.

A 60/40 index can help comparison
As the bulk of assets flow into “balanced” multi-asset funds with a 60% equity allocation, we created a 60/40 equity/bond index for GBP investors to provide a comparator for multi-asset funds.  This means that investors can evaluate multi-asset fund managers skill at 1) creating optimised portfolios over a “boring” 60/40 portfolios; and 2) evaluate the value added by dynamic asset allocation decisions relative to a static-weight index.  While additional indices for different risk profiles may make sense in the future, we believe a 60/40 index is an important first step.