Multi-asset funds promise access to a whole palette of asset classes and the ability to move between them as opportunities arise or disappear. With many pension investors under increased pressure to derisk, how is the role of multi-asset funds changing? 

 

One of the lessons of the financial crisis – and also the pandemic crash of early 2020 – was that the trustee meeting cycle is perhaps not all that well suited to taking investment decisions in reaction to market moves, and some have sought to outsource some of the investment decisions since. For those without the in-house capacity to assess global markets in detail, multi-asset funds can be one way to do that. 

 

“I believe there will always be a place for multi-asset in one form or another among smaller pension funds, or those with a lower governance resource,” says Natalie Winterfrost, a director at LawDeb Pension Trustees. “As we all know, ‘diversification is the only free lunch’, and there are situations where a fund manager can oversee that diversification more efficiently than a trustee board can.” 

 

 

Multi-asset funds come in many guises, frequently also sporting the ‘diversified growth’ label, and range from relatively simple passive balanced mandates to complex active and absolute return structures. For trustees, knowing which type of multi-asset fund fits into their portfolio and identifying it from among the hundreds on offer is therefore paramount. 

 

    

A relatively passive, diversified beta type multi-asset fund has “less of a place in a well resourced and well advised scheme” than a more alpha-seeking fund, says Winterfrost; such a scheme “can probably get the componentry cheaper and structured in a form most suited to it”. On the other hand, it could also choose to invest in an external absolute return style multi-asset fund, as this can be “a good diversifier, particularly in down markets”, she notes. 

 

Some larger investors have gone down this route, including local government investment pools. In March, LGPS Central Limited was looking for investment managers to run its roughly £700m targeted return fund, while last year Brunel Pension Partnership created a £1.2bn ‘diversifying returns’ fund for its clients – mainly to offer downside protection – choosing four different managers. 

 

Though she welcomes the diversification multi-asset offers, Winterfrost nonetheless says she would sound a note of caution when it comes to absolute return funds because ‘closet beta’ – where a supposedly active fund largely tracks an index – can be difficult to detect in such a vehicle. The returns on many funds have also been disappointing, she adds, advising that “future return targets may need to be taken with a pinch of salt as aspirational, rather than realistic”. 

 

 

While more return-orientated vehicles may have struggled to justify their performance amid a historic equity rally in the past few years, pension funds may now be showing some appetite for income-generation as more are turning cash flow negative and the equity market has become more volatile. 

 

“We see more demand for income-orientated solutions,” says Paul Flood, a portfolio manager at Newton Investment Management. “We prefer to provide natural income from dividends and coupons,” he says, but “ultimately what we want to deliver is a sustainable income for clients”, arguing that a mix of income and growth is required to achieve this. “Multi-asset can help to moderate extreme outcomes by embedding a range of scenarios,” he adds. 

 

With bond yields at historic lows, some are looking to alternatives to give exposure to income streams – preferably with inflation protection. One such source of income may be rather new to pension funds; Flood says music royalties are a largely untapped source of regular cash flows.  

 

Another income-generating alternative included in some multi-asset funds is infrastructure, but aside from cash, infrastructure can also offer exposure to the green transition. “ESG is an incredibly important part of the mix,” says Flood, though he adds that “trustees need to be clear what they expect from ESG because there are many different flavours”, which range from ESG risk assessment to the application of strict exclusion criteria. 

 

 

ESG integration in multi-asset is found in newer funds, says Daniel Peters, a partner in consulting firm Aon, while "with products that have been up and running for a long time it’s been slow". 

 

For Peters, multi-asset funds can either be used as a way to move more easily between asset classes or as a governance solution, but the latter is preferable in his view: “What we’ve seen, where it’s being done to cross-allocate, it’s been difficult to add value given strong returns from equities.” Funds that have performed better typically also have a higher equity exposure, he says. 

 

Among DB schemes, interest in multi-asset is muted as they look for diversification elsewhere, for example in the illiquid credit market, he argues. Where funds use diversified products, they often do so within an asset class or theme, including credit or sustainability. 

 

For defined contribution schemes, there could be demand, he notes, not least because of the relative liquidity of multi-asset, though he adds that potential underlying illiquid holdings have not been tested in a down market yet.  

 

“It comes back to thinking carefully about the role of the multi-asset fund” and “whether that could be done in an easier and cheaper way”, says Peters, as multi-asset funds tend to be at the more expensive end of the range.  

 

Aside from cost, independence – the ability to invest in any fund rather than just in-house products – is key, he says, while ESG will also be part of the selection criteria.  

 

 

For others, multi-asset funds are a useful stepping stone between equities and fixed income on the DB derisking journey. A DB scheme might reduce equities and invest 20-30% of its assets in multi-asset, then gradually reduce this to 10% as funding improves and derisking triggers are met, says Brendan McLean, an investment research analyst at Dalriada Trustees. 

 

But with multi-asset traditionally using bonds as protection, there is now a question about whether this approach will continue to work if central banks start raising interest rates, he says. “It might not offer as much protection in future, that’s why there is a bit more interest in risk parity type strategies. The ones we use have a tail-risk hedging strategy as part of the building blocks of the portfolio,” he notes, which 'kick in' if markets decline. 

 

McLean says there continues to be interest among pension funds. He believes multi-asset has a place for smaller schemes with low governance: “For those who still need growth, multi-asset is still a good fit."