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Simon Evan-Cook: Navigating the asset allocation minefield

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If you have met with a multi-asset fund manager recently, you may well have asked a variation of the question: how important is your asset allocation? This is useful to know but beware – it is two questions disguised as one.

To avoid a costly mistake, you must understand which question the fund manager is answering.

The first of the two questions within a question – and it makes good sense to ask this one first – is to find out if the fund is tethered to an anchor asset allocation (that is, 60 per cent equities, 40 per cent bonds). This is about establishing the product’s bedrock design, not its day-to-day management.

Is this important to future returns? Yes. When people talk about asset allocation being responsible for 90 per cent of returns, this is what they mean (or at least they should do). A fund that permanently holds 80 per cent in gilts will underperform a stockmarket rally while an 80 per cent equity fund will lose ground in a savage bear market.

For advisers, defined bound-aries within a multi-asset fund make it easier to assign to different bands of clients, even if those boundaries restrict that manager’s flexibility.

Conversely, a fund with total flexibility opens up the possibility of finding a Holy Grail that will excel in all conditions. But this also raises the considerable risk of returns falling uncomfortably wide of your clients’ comfort zone if the manager gets it wrong. That will establish what sport the manager plays but you also need to know how they play it.

The second of the two questions within a question is: How important is your “strategic” or “tactical” asset allocation? This establishes if and why a manager will temporarily position the fund away from its anchor asset allocation, so is relevant for performance against his peers rather than absolute returns. It is not as important as the anchor allocation: better to be in the wrong part of the right ballpark than the opposite. But it is still important to know.

From this question, there are essentially two sets of two variables, making up four basic options – fixed alloc-ations with passive building blocks; fixed allocations with active building blocks; movable allocations with passive building blocks; and movable allocations with active building blocks.

If the manager puts himself among the first two fixed allocation options, then temporary asset allocation moves are not allowed and therefore do not dictate future returns. If they are in the latter two, you can assume the manager believes such moves will be important to relative returns or they would not bother making them.

Most risk-targeted fund ranges fall within the first two options although some allow themselves more flexibility to deviate from their designated allocations. For our part, we believe managers should be wary about straying too far: advisers who favour this product are trying to manage their clients’ expectations. They will rightly be peeved if an errant allocation call loses them business.

But where multi-asset funds do have stated flexibility, we think active allocation is useful. Our preference here is to focus on asset valuation over a macroeconomic outlook. Economists cannot decide what happened in the past, let alone the future, so we would be bonkers to give them responsibility for anything more important than their own choice of underwear.

Simon Evan-Cook is senior investment manager at Premier Multi-Asset Funds

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