An answer in the search for yield: multi-asset funds

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Multi-asset funds are seeing more and more interest from a wide variety of investor types, including individuals, private banks and institutional investors, in their search for yield in a market environment marked by weak economic growth, low interest rates and disinflation. In this article, we discuss the reasons for the growing demand and the scope for further asset growth.

For some time, multi-asset funds have been on a roll, be it funds whose main objective it is to distribute a sustainable income or funds that seek to maintain the risk within a certain volatility bandwidth through an optimal diversified allocation. Both categories enjoyed substantial inflows in 2014 and we see no reason to expect a change in this trend in 2015.

Tough times in the search for yield

The current environment of historically low interest rates complicates the task for investors in search of yields. Whereas they may previously have held significant allocations to traditionally ‘risk-free’ sovereign or quasi-sovereign bonds, yields now generated by these typically highly-rated bonds are simply too low relative to investors’ needs: French 10-year Treasury bonds currently yield less than 0.6% on an annual basis and the yields on their German equivalent are even lower (see chart).

Corrected for inflation, the yield that an investor can expect on this type of security is now close to zero. The same applies to many life insurance policies, whose yields have been in constant decline for several years. Today, with returns barely above the rate of inflation, such investments no longer reward investors adequately. High-income equities, high-yield corporate bonds and emerging markets debt offer higher real yields, but expose investors to a greater risk of loss in capital. Their challenge is thus to generate an attractive portfolio yield without sacrificing too much in terms of stability and security.

The yield on the 10-year German sovereign bond has been falling since 1990

Going beyond the obvious

To obtain an attractive – and regular – return, we believe a better approach could be to opt for a broader investment universe beyond government bonds. Hence the attractiveness of a multi-asset investment approach: by including strategic allocations to riskier asset classes in a well-diversified portfolio, investors can in our opinion earn an additional yield of 4% to 5% on top of government bond allocations without having to take excessive risk.

Multiple assets, multiple allocations, mitigated risks

Aiming for higher returns does not mean avoiding the safest investments and favouring the riskiest. But in the current environment, investors have little choice but to take on more risk. Here, a well-diversified portfolio can help mitigate the downside risk. Thus, multi-asset investing can offer a more consistent and higher risk-adjusted return than investing in single asset classes.

Some multi-asset funds actively vary the weightings allocated to the different portfolio assets, so that risks can be managed adequately in times of market stress whilst allowing the portfolio manager to seek opportunities across asset classes.

Specific features of multi-asset funds

While some multi-asset funds are focused purely on generating a sustained income, others seek to also increase the original investment, i.e. realise capital gains. To achieve this, these funds draw on a very broad investment universe, including equities in developed and emerging countries, high-yield US and European corporate bonds, listed property in the US, European and Pacific regions and government bonds. Thus, there is wide diversification, both in terms of asset classes and regions.

These funds often have a flexible allocation process to capture the opportunities offered by such a wide range of asset classes while being able to reduce the exposure to the riskiest assets when markets become volatile. As well as being able to vary weightings between regions and asset classes, some funds invest actively within each asset class with the help of specialist teams so as to focus on those securities providing an attractive, quality yield that is sustainable over time.

In our view, multi-asset funds should not chase performance at any price, but balance the expected yield and risk. The volatility of returns differs depending on the investment strategies (see below). However, the common theme is to earn a performance that will appeal to investors searching for yield without driving them towards concentrated investments in volatile asset classes. We believe both a volatility-focused and an income-oriented approach deserve a place in today’s portfolios.

Favourable conditions for further demand

Multi-asset funds are benefiting from a favourable environment that has enabled them to grow significantly in 2014. Private bankers, asset managers and individual investors are all increasingly advocating or seeking this type of investment. Similarly, a growing proportion of insurers are introducing diversified, income-generating solutions into their life insurance policies.

Looking ahead, flexible multi-asset funds that can balance the risk inherent in their exposure to riskier assets should, in the current increasingly uncertain and volatile environment, be well-placed to deliver stable and attractive returns for today’s risk-aware investors.

Pierre-Amaury Tabarly

Investment specialist, Multi Asset Solutions

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