- Investment Insights
- 5 minute read
In its simplest form, multi-asset investing is about holding a mix of different types of investment. Company shares and government bonds are among the most common types of investment held, however in recent years the range of investments readily included under the ‘multi-asset’ umbrella has expanded widely.
The evolution of multi-asset investing
The concept of multi-asset investing has undergone a substantial shift over the past 20 years. For many years, multi-asset funds or portfolios were generally split between shares and bonds in allocations aligned with risk appetite. A moderate risk, or ‘Balanced’, portfolio for example, would have something close to a 50/50 split between equities and bonds. For an individual investor in the UK, the equities would have likely been predominately UK listed companies, and the bonds UK government bonds (gilts) and corporate bonds issued by UK ‘blue chips’. The equities provided the potential for growth, while the bonds were meant to preserve capital and generate a steady and sustainable income.
Whilst the evolution of multi-asset investing was already well underway, the general declines in the stock market that followed the Dotcom bubble and the Global Financial Crisis undoubtedly served to accelerate the process, exposing as they did the shortcomings and outdated nature of a basic split between bonds and equities. At times of acute market stress the correlation between asset classes increases, and both equities and bonds can suffer. Simply put, the traditional multi-asset allocation was no longer proving adequate.
As contemporary financial markets made it possible for UK investors to efficiently access global markets – as well as ‘alternative’ asset classes, such as commercial property, private equity, hedge funds and infrastructure – investment managers had to obtain a better understanding of the increasingly broad range of asset classes and strategies available to them. It logically followed that those managing multi-asset retail funds or private client portfolios should incorporate such investments for optimal diversification (a strategic mix of a wide variety of investments within a portfolio to limit exposure to a single asset class).
Modern Portfolio Theory
Hypothetically speaking, the perfect investment would generate high returns with little or no risk. The reality is that such an investment is all but impossible to find – there is always a trade-off between risk and reward which investors need to weigh up. Of all the strategies created and put to work in search of the best risk/reward investment, none have been as popular and as consistent as Modern Portfolio Theory.
Developed by economist Harry Markowitz in the 1950s, Modern Portfolio Theory hypothesises that it is possible to build an ideal portfolio – an optimal blend of assets – that will deliver the best possible return for a given, quantifiable level of risk. The theory promotes diversification of asset classes and securities in particular; not putting all your eggs in one basket, but also appreciating how an investment might affect the overall portfolio’s risk and return.
Modern Portfolio Theory states that potential investments are subject to both systematic risks – such as recessions, interest rates, geo-political unrest and even the weather – as well as unsystematic risks, such as issues particular to a certain stock – a change of company management for example. The theory suggests that while adequate diversification cannot avoid systematic risk completely, it can significantly reduce – and potentially eliminate – unsystematic risk. As a result, the risk/reward trade-off should improve, and investors should enjoy better outcomes than those which would otherwise have been achieved given the prevailing market backdrop.
Understanding risk and reward
Despite the fact that Modern Portfolio Theory has been a mainstay of multi-asset investing since the 1950s, the concept – and how it drives the processes investment managers put in place – can still be poorly understood outside of the financial services industry, and sometimes poorly explained or represented to laypeople.
Inconsistent use of jargon and terminology across the industry (and even within financial services firms) can confuse matters and make comparing the performance of different multi-asset solutions extremely challenging. There are no universally used multi-asset benchmarks – a “Balanced” or “Moderate Risk” portfolio provided by one firm can be very different to a portfolio given the same label by another firm, despite all claiming to sit at the middle of a risk-reward spectrum. Investment managers offering multi-asset solutions do not choose their investments from the same, easily defined pool of investment choices and a ready-made benchmark derived directly from a market index (in the same way most UK equity fund managers do with the FTSE All Share, for example). The industry standard sectors or benchmarks used are very broad, meaning that resulting portfolios and outcomes can also be very broad.
The theory might underpin what all multi-asset investment managers do, but putting it into practice can be done in numerous and continuously evolving ways. As what constitutes ‘balanced’ or other levels of risk can be subjective, it can help to work with a qualified financial adviser. An experienced adviser will understand the details of your circumstances, needs and attitude to risk, as well as exactly how an investment manager is running your investments. They will help to determine the best investment opportunities to meet your goals, monitor your investments and provide advice if your circumstances change. Remember, the value of investments will go up and down and you may get back less than you invested.
To find out more, or arrange a consultation with an adviser, don’t hesitate to request a call back.