Key Takeaways
- The top-performing multi-asset funds over the last three and five years are relatively straightforward portfolios built around global equities and bonds, Morningstar data shows.
- Faced with new challenges, some fund managers are expanding their toolkit to a wider range of instruments and risk management strategies.
- But these tools come with higher costs, making it harder for flexible allocation funds to outperform over longer time periods, Morningstar analysts say.
The appeal of multi-asset investing in strategies like a 60/40 portfolio has rested on a relatively simple formula: Combine stocks for growth with bonds for stability, rebalance periodically, and let diversification—and rising index returns—do the hard work.
But inflation, higher interest rates, and greater geopolitical uncertainty have challenged the traditional relationship between equities and bonds, prompting some fund managers to expand their toolkit to a wider range of instruments and risk-management techniques. Commodities, trend and momentum-following strategies, as well as derivatives, are increasingly appearing alongside the traditional building blocks of a diversified portfolio— but at what cost?
Multi-asset or allocation funds invest in major asset classes such as equities and bonds. Usually these funds assign a fixed proportion of their portfolios to stocks or bonds: Funds in the GBP Allocation 40-60% Equity category, for example, invest 60% in equities and 40% in investment-grade bonds. This is known as a “60/40 strategy,” and it aims to balance risk and returns for portfolio diversification.
Jason Kephart, senior principal for multi-asset strategy ratings at Morningstar, says the purpose of the 60/40 portfolio is “to combine two assets with different risk characteristics to create a smoother investment experience.”
The objective of diversification “isn’t to avoid periodic losses. Those are an unavoidable part of investing,” he says. “The real goal is to reduce the severity of those short-term losses so investors can remain committed to their long-term plan through difficult markets.”
Funds in the GBP Allocation 80%+ Equity category invest an even greater proportion of their portfolios in equities, aiming to achieve higher returns at a time of rising stock markets.
Another group of funds known as “unconstrained,” such as those in the GBP Flexible Allocation category, allow managers to choose what proportion of assets they hold in their portfolios and make changes to those allocations based on market conditions. One of these, Invesco Balanced-Risk Allocation fund, has managed to beat 60/40 portfolios this year so far with a gain of 17.63%.
This Bronze-rated fund combines long and short positions investing in equities and bonds. Futures contracts linked to 10-year G7 government bonds are nearly 100% of the portfolio, with the manager betting on the price movement of sovereign bonds without owning the underlying asset.
Simpler Portfolios Have Outperformed
The long-term numbers are more supportive of the idea of keeping it simple. Morningstar data for Medalist-rated multi-asset funds over the past three years show that many of the strongest-performing are standard portfolios with fixed equity allocations. This reflects a combination of market fees and generally lower fees on these funds than on the flexible strategies, according to Tom Mills, principal, multi-asset strategies at Morningstar.
On the performance side, strong equity returns have rewarded investors who remained fully invested, while attempts to tactically adjust portfolios often proved costly. Many of the best long-term performers simply maintained strategic allocations, kept costs low, and captured broad market returns during a period when passive equity exposure has been difficult for active managers to outperform. “Our research shows that at a high level, cheaper funds perform better than expensive funds,” says Mills. “And funds that have not done a lot of tactical allocation have probably done better [over the long term].”
The best-performing Medalist fund over three and five years is Silver-rated Artemis Monthly Distribution, which is a 60/40 fund. Top bond holdings include government debt issued by the US and Germany. Over three and five years, the fund has returned 20.06% and 11.06% on an annualized basis and is in the top 1% of funds in its category.
“Long-term performance of the strategy has been very strong, and it has outperformed its peers and benchmark over its life in both absolute and risk-adjusted terms,” says Mills.
Sophisticated Trading Tools Add Costs for Multi-Asset Funds
Many traditional multi-asset funds invest almost exclusively in equities and bonds through inexpensive index funds. Introducing commodities, options, derivatives, and specialist strategies increases both portfolio complexity and ongoing costs, making manager skill more important.
Morningstar’s Mills adds that expensive, flexible funds can and do outperform, but higher fees make it harder to do so. While two flexible allocation funds are in the top 10 performers over three years—GMO Global Real Return and Nedgroup Global Flexible Fund—the list is dominated by funds with a fixed 60% or 80% allocation to equities.
The median fee in the GBP Flexible Allocation category is 1.03% per year, versus 0.95% per year for the GBP Allocation 40-60% Equity category.
Matt Wiles, head of fund research at EQ Investors, a UK wealth management and planning firm, says investors should be clear about what these additional strategies are designed to achieve. “I’d want to understand the purpose of it,” he says. “If it’s simply to leverage up and take more risk, then it probably isn’t for us. But as risk hedges, I’m generally comfortable with the concept.” He says that any additional strategy should improve a portfolio’s overall resilience rather than simply add complexity: “It’s trying to build a portfolio that better weathers different market conditions.”
However, some strategies can be difficult for investors to live with. For example, tail-risk protection offers a buffer against extreme market events, such as the covid selloff in March 2020. These can include buying call options on the CBOE Volatility Index. These financial contracts are profitable when the index rises sharply during market crises. Or it can mean some of the multi-asset fund’s portfolio is allocated to hedge funds that are “short” equity indexes, and so profit when markets fall.
But tail-risk protection often generates a steady drag on returns until periods of stress, when it suddenly becomes highly valuable. “They’re great, but every month, you’re explaining why they’re costing performance until the moment you actually need them,” Wiles says.
That creates an important challenge for fund managers. Sophisticated risk-management tools may improve diversification over a full market cycle, but investors must be willing to accept periods when those strategies appear to be detracting from returns.
