A multi-asset portfolio is composed of a blend of different asset classes. Typically, it will contain a mix of equities, bonds, cash, property, commodities, currencies, private equity and hedge funds.
An asset class is a type of investment, for example, equities or cash, and should not be confused with underlying industry or geographical segments. US equities and UK equities belong to the same asset class and no regional distinctions will be made at asset allocation level.
Different sectors and asset classes tend to perform well or badly at different stages of the investment cycle. For example, in an environment of rising growth, equities are likely to perform relatively well while bonds and cash are more likely to outperform during periods of declining economic growth.
History shows that equities have provided the best long-term returns but the bursting of the dotcom bubble sent the equity market into one of its biggest meltdowns in years.
Bonds are widely perceived to be low risk. However, recent events in the credit market have reduced the appeal of corporate bonds. Cash is often viewed as the safest home for your money but inflation is likely to erode much of its value over time.
By mixing assets which behave differently in various economic conditions, the manager aims to balance out the performance of a portfolio. If a higher-risk asset is added to the mix, the manager may decide to offset the effect generated by this investment by adding another asset that is uncorrelated to the first. In the event that the higher-risk asset’s value suddenly drops or rises, the other asset’s performance should remain unaffected, softening the effect on the portfolio.
Until a few years ago, multi-asset investing was generally available only to institutional investors and pension funds. However, following the downturn in the equity market in the wake of dotcom mania, private investors’ interest in multi-asset funds began to grow, not least because their strategy of diversification demonstrated that they were well positioned to cope with market volatility.
Risk is a crucial element when structuring a multi-asset portfolio. The manager is aiming to maximise the potential for reward within a given level of risk. They need to be skilled in tracking and monitoring evolving risk/reward relationships to ensure that the fund remains positioned to deliver optimum performance.
When deciding to make an investment, investors should determine their own attitude to risk based on their personal investment goals and timescale. The investor needs to take enough risk to allow them the best chance to attain their financial goals but they should also ensure that they are not taking excessive risk to reach a relatively unchallenging target. When combined with the risk planning tools that are employed by many IFAs, multi-asset investment can provide a welcome solution.
Crucially, a multi-asset manager aims to blend the right combination and proportion of assets to maximise the potential for gain while minimising downside risk and give the fund the opportunity to perform well in most market conditions. Studies have shown that most of the variation in portfolio performance is attributable to asset allocation, with only a small proportion due to market timing or underlying stock selection.
Returns from a multi-asset portfolio are likely to be less volatile than a more focused portfolio. A more concentrated portfolio might generate high returns for short periods of time by focusing solely on one hot asset class or sector but this is a high-risk approach and performance is likely to be very volatile.
Above all, a multi-asset approach offers a well diversified portfolio that can provide exposure both to traditional and specialist investments, with the ability to perform well in most market environments.
Multi-asset investing provides flexible and dynamic asset management based on a firm long-term foundation. A multi-asset portfolio can be used as a stand-alone portfolio for an investor looking for a complete solution or as a core portfolio that can sit alongside specialist satellite investments.
If you accept the basic premise of modern portfolio theory that combining various securities which display low or non-correlation can improve the risk/return metrics of a portfolio, it can be argued that adding additional asset classes such as hedge funds or commodities can be beneficial to your portfolio.
Patrick Murphy is director of wealth management at Thinc