Why Invest in Multi Asset Funds?Download this article in PDF
Whether you goal as an investor is capital growth, income generation or simply inflation protection, it all comes back to the same equation: getting attractive returns with a minimized risk of losing its capital. Investing today is a lot more challenging than it used to be 20 years ago. Back in 2000, investing in US government debt was delivering a 5% return with little or no risk. Put simply, by then, you needed a capital of $2 million to generate a $100k annual income. Today, for the same result, you will need a mere $3.6 million in capital.
The direct consequence of this was that investors turned to riskier and more complicated investments in search for higher returns. But as the complexity of investments grows, so is the need for highly skilled managers in order to mitigate and diversify the additional risk taken on.
In that philosophy, multi asset funds offer an efficient solution to the challenging conditions of today’s world of investing. Empirical studies have shown that the success of multi asset strategies lies with 4 basic pillars.
PILLAR 1: INVESTMENT VERSUS CASH
In the medium to long term (5 to 10 years), all asset classes historically have generated real returns, meaning above inflation (See figure 1 below). Don’t forget that by sitting in cash, you are not adopting a conservative strategy; you are only condemning your capital to loose buying power day after day due to inflation. Investing is of course, not risk free, but it is a much wiser alternative, where risks can be managed.
The most feared risk of investing is to buy at the top, right before the markets take a downturn. One way to mitigate this risk is to invest for a long enough time horizon, so that even if entered at the top, annualized returns are still positive. The other big tool for investors to protect themselves from market timing is diversification; we will address this one in our third pillar of basic investing principles.
One of the perks of investing is the compounding effect. By investing, and staying invested, you are not only accumulating gains year after year like you would do by stacking up your savings under a mattress every year, you are allowing your profits to be automatically re-invested in order to deliver “profits on profits”. This compounding effect is what allows your portfolio to grow exponentially as illustrated in the figure 2.
PILLAR 2: ASSET ALLOCATION DRIVES PORTFOLIO RETURN AND RISK.
In 1986, Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebowe published their famous study entitled “Determinants of Portfolio Performance”. The objective was to figure out what drove portfolio returns and risks. Their findings have been confirmed by countless of other research materials and are still used by the biggest and most important investors today. Their conclusion was that the strategic asset allocation of a portfolio is responsible for the vast majority of return and risk (see figure 3).
What it means essentially, is that spending time analyzing if the General Motors stock will perform better than the Ford one is not an efficient way to employ its time and neither is trying to guess when the market is going to make its next top. What really matters is choosing the right asset classes to invest in and in which proportions.
In the figure 4, we can observe the ranked annual return of every asset class, and what we can immediately take from that representation, is that the winners and losers are very different year after year. Strategic asset allocation is just that; trying to be invested in the best performers and avoiding the lagers. Although not easy, it is a much more productive use of its time and resources than to concentrate its effort on stock picking and market timing. As a consequence, if a multi asset fund manager must be successful over the long term; most of its efforts must be dedicated to the fund’s asset allocation.
Figure 4: Ranked annual asset class returns (January 1994 to December 2016)
PILLAR 3: MODERN PORTFOLIO THEORY
The third pillar is once again evidenced by empirical data, and is probably the oldest rule in the investing world: diversification across a portfolio of asset classes reduces risk and increases risk adjusted returns.
Figure 5 shows the effects of diversification on return and volatility. Not only does it reduces the volatility but also improves returns.
A diversification strategy can help you achieve more consistent returns over time and reduce your overall investment risk. It is key to any long term investment strategy.
PILLAR 4: INDEXING OUTPERFORMS IN TRADITIONAL ASSET CLASSES.
For traditional asset classes, low cost index investing is likely to outperform the majority of actively managed investments and the likelihood of outperformance increases with time (see figure 6). Indeed, the rise of Exchange Traded Funds has offered a significantly improved tool in order to invest in traditional assets commonly known as stock and bonds.
- Here are just a few advantages of index investing:
- Index investing offers greater transparency and lower costs relative to active management and now represents a USD 6 trillion market globally.
- Index tracking investments provide an efficient method of implementing an asset allocation.
- Index investments tend to outperform actively managed funds over the long term due to the higher costs of active management and the difficulty of predicting future security values.
Figure 6: Percentage of active funds that did not outperform their indexes.
The diversified, strategic and low cost nature of the multi asset funds make it a suitable ‘core holding’ within your overall portfolio. By combining asset classes that do not rise and fall at the same time, the risk of investment is reduced and the return on investment increases. Quality multi assets funds are a great tool to use as a base holding on which you can add other investment vehicles and opportunities. In today’s market, investing with approximation is a dangerous endeavor so be smart and make sure that your capital is invested respecting the 4 basics pillars. What better way to that than using a multi asset fund?
If you would like to have more information about multi-asset investment fund, please contact Romain Dromard, manager of the Vitae Patrimonial Fund.
For more Information:
Chief Investment Officer – Managing Partner
+ (507) 209 2944
May 27, 2018