Multi Asset Investing The importance of staying active

As quantitative easing is gradually withdrawn, causing global liquidity declines, and increasing the cost of borrowing, market dispersion is likely to rise. With a wide-array of tools at their disposal, active multi asset managers can provide investors with equity-like returns, just with less volatility than if they purely invested in equities.

Oct 2018

Equities historically have produced superior returns over the long term1. Over shorter periods, however, equity returns can fluctuate significantly.

Fig. 1 shows that if one held US equities for only one year between 1900 and 2018, the returns varied between -61% to 133% – a very volatile range triggered by investor sentiment and market events. If the holding period was extended to 10 years, then the range narrowed to -5% and 21% per annum (p.a.). With longer holding periods, volatility decreased and returns stabilised in the positive range.

Fig 1: US equities annualised total returns (%), 1900 - 20182


Given the significant performance divergence in shorter holding periods, for investors who may not have the luxury of extended holding periods, how can they achieve good stable returns?

Diversification brings steadier returns

A multi asset portfolio seeks to deliver steadier returns even for shorter holding periods. By including defensive assets, drawdowns can be lowered during market downturns, such as holding government bonds during the 2008 global financial crisis.

Fig.2 shows that a portfolio with a static allocation of 60% global equities and 40% global bonds would have registered a much lower volatility of 9.60%, as compared to 14.26% for global equites, over the past 15 years.

Fig 2: Performance of a 60/40 global equity-bond portfolio, rebalanced quarterly to maintain the allocation3


The lower drawdowns, however, came with lower returns. The 60/40 global equity-bond portfolio delivered a total return of 7.08% p.a., lower than the 8.74% annualised return of the global equity portfolio.

Nevertheless, the 60/40 portfolio still delivered a higher return per unit of risk. The diversified portfolio had a Sharpe ratio of 0.63, versus 0.57 of the MSCI World index4.

Cruising through undulating terrain

To enhance returns further, exposures can be ‘actively’ adjusted across asset classes instead of sticking to a static allocation as in Fig. 2.

Similar to how a cyclist uses a low gear when riding uphill, an active multi asset manager typically invests in more defensive assets during a recession (see Fig.3). A middle gear is selected on undulating terrain with a mix of defensive and riskier assets, depending on market conditions and risk profiles. A high gear is selected for high speeds on flat terrain, with more capital invested in riskier assets, such as equities, which tend to outperform during economic expansions.

Fig 3: All-weather asset allocation to cruise through economic cycles5


As illustrated above, a multi asset strategy allows investors to stay invested and enjoy superior risk-adjusted returns, as the manager actively allocates to different asset classes amid different economic cycles. Studies show that active asset allocation is a key contributor to performance success in multi asset portfolios6.

Even within the same asset class, different markets and sectors can perform differently. This can be seen from the divergent performance of US small caps and emerging market equities year to date.

High current account deficits, hyperinflation in Turkey, and a stronger US dollar have triggered sell-offs across emerging markets equities this year, as seen in Fig.4.

In contrast, US small-cap equities – benefiting from tax cuts and deregulations – have rallied 11.51% year to date7.

Fig 4: Performance of US small-cap equities and emerging markets equities year-to-date7


The importance of being active

How long will this divergence last? What triggers will create the next set of leaders and laggards?

By observing market conditions with logic, and conducting in-depth analysis on valuation, sentiment and macro factors, experienced active multi asset managers can add value to investors.

Different reactions and utility functions of market participants also make financial markets inefficient, creating a wealth of opportunities for active managers to exploit. By identifying sectors and markets that are likely to outperform, and avoiding exposures to underperforming ones, a multi asset strategy can boost risk-adjusted returns.

Multi asset managers also have more tools at their disposal and can execute their strategies using delegated mandates, funds, exchange-traded funds (ETFs) and derivatives.

As quantitative easing gets withdrawn, causing global liquidity declines, market dispersion is likely to rise. Against such a backdrop, investors can look to a multi asset strategy to help buffer against potential market dislocations while capturing new investment opportunities that emerge.

1From 31 January 1990 to 31 August 2018, global equities (MSCI World) returned 7.02%, while global bonds (Barclays Global Aggregate Bonds Unhedged USD) returned 5.67%, both annualised total returns with income re-invested in US dollars. Past performance is not a guarantee of future returns. Investment cannot be made directly in the index.
2Eastspring Investments, Datastream, Robert Shiller ( Standard & Poor’s 500 index, index returns plus dividend re-invested, data from 1 January 1900 to 4 September 2018.
3Morningstar Direct, from 21 September 2003 to 22 September 2018, global equity portfolio is represented by MSCI World, diversified portfolio is represented by 60% MSCI World and 40% Bloomberg Barclays Global Aggregate Total Returns USD, quarterly re-balanced, both in US dollar terms. Monthly returns. Past performance is not a guarantee of future returns. Investment cannot be made directly in the index.
4Morningstar Direct, risk free rate US Treasury Bill Auction 3-Month Average. Sharp ratios calculated based on monthly returns from 21 September 2003 to 22 September 2018. Past performance is not a guarantee of future returns. Investment cannot be made directly in the index.
5Eastspring Investments. For illustration purposes only. The information provided herein are subject to change at the discretion of the Investment Manager without prior notice. DM stands for developed markets. EM stands for emerging markets.
6Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance? Roger G. Ibbotson and Paul D. Kaplan, © 2000, Association for Investment Management and Research.
7Thomson Reuters Datastream, data from 29 December 2017 to 28 September 2018. Total returns with dividends re-invested in US dollars. US small caps are represented by Russell 2000; emerging market equities by MSCI Emerging Markets. Past performance is not a guarantee of future returns. Investment cannot be made directly in the index.

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