SWFs Weigh Multi-Asset Strategies in Hunt for Alpha — And Lower Risk

July 01, 2015 by Loch Adamson

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Warren Buffett

Sovereign wealth funds are mulling the pros and cons of investing via multi-asset managers, who may have the freedom to allocate money to everything from commodities to real estate.

Many of history’s greatest investors have been so-called multi-asset managers, dabbling where they see the best opportunities and shifting the capital they oversee among stocks, real estate, bonds, currencies or cash. Consider such out-of-the-box thinkers as Berkshire Hathaway CEO Warren Buffett, George Soros of Quantum Fund fame, and John Maynard Keynes — multi-asset managers all.

Over the past 18 months, industry experts say, big institutions like sovereign wealth funds have taken a closer look at multi-asset managers. "Since the global financial crisis, the investment and risk landscape is more complex, and the risks are extensive, so they are looking for new solutions to help them deal with it," says Erik Knutzen, chief investment officer of multi-asset at Neuberger Berman, the New York-based asset management firm.

Adding a multi-asset strategy allocation to a portfolio tends to increase its overall diversification, and may give lightly-staffed sovereign wealth funds access to expertise in corners of the market it might lack internally. Such multi-asset managers tend to reallocate opportunistically. "That is different to what a traditional asset allocation team in a sovereign wealth fund does," says Michel Meert, director of investment advisory for professional services firm PwC. 

Reducing Risk

It’s difficult to come up with performance data on multi-asset strategies since people’s definitions of them vary widely. They can range from a simple balanced stock and bond portfolio to a free-roaming hedge fund that dabbles in soy futures, interest rate-based derivatives and stock options, says Jeff Holt, an analyst on the mult-asset management research team at Morningstar, the Chicago-based financial publisher. "Multi-asset is an all-encompassing term," he says. "There are a lot of variations."

For example, some multi-asset managers are focused on diversification to reduce risk, says Chris Nichols, who is responsible for the development and management of multi-asset investment strategies for institutional clients at Edinburgh-based Standard Life Investments. To this end, the managers seek to balance investment risk across many different positions, using derivatives as necessary, to diversify and protect the portfolio against sudden market shocks.

"Theoretically, 'go anywhere’ management makes sense," says Holt. "Having a good manager navigate through the cycles. The implementation is the problem."

One question is how much of a fund’s assets needs to be turned over to such managers to achieve a meaningful impact on the overall portfolio, whether it be through higher performance or lower risk. Andrew Clare, a professor at the Cass Business School in London, wonders whether the alleged benefits are really tangible for very large investors like sovereign wealth funds. "Even if you put 10 percent of your portfolio into a multi-asset fund, you’re not really going to get much diversification benefit from such a small allocation," Clare says. Indeed, state-owned investors aren’t even allocating that decile of their assets to multi-asset strategies. 

"Greater Freedom"

Clare says that sovereign wealth funds concerned about diversification should look at the overall portfolio, and not focus on the relatively small portion of their assets that they are likely to allot to even a talented multi-asset manager. "Independent academic studies consistently show that the vast majority of a portfolio’s overall performance is driven by the investor’s asset allocation policy, and, to a much smaller extent, its tactical asset allocation," he says.

Holt says it’s important to have enough confidence in a manager to stay invested through a market cycle. That confidence is what will determine how much is appropriate to invest. "We look at histories and results," he says. "Even good ones will go through laggard periods." Among the managers Holt says Morningstar views favorably are some employed by New York-based BlackRock, Boston-based GMO and a fund subadvised by Research Affiliates' founder Rob Arnott for Pimco, the giant bond fund manager based in Newport Beach, California.

Sovereign wealth funds’ interest in multi-asset strategies is largely driven by a hunger for returns. Neuberger Berman’s Knutzen says many state-owned investors, like pension funds, are struggling to meet expectations shaped in the pre-financial crisis era. "Return expectations are generally pretty low for traditional assets today, given the environment of record-low yields and moderate economic growth," he says.

More advanced multi-asset managers are no longer tethered to simple market benchmarks like the Standard & Poor’s 500 Index. Some can hunt more effectively for opportunities that offer better outcomes than a marginal return above an index. "They have greater freedom to make investment decisions that offer a positive return and use asset classes that index-constrained managers cannot access because their mandate ties them to stay close to the benchmark," says Standard Life’s Nichols.


Nevertheless it remains critically important to have some measure of their performance, even if it’s a less conventional benchmark, say, the inflation rate plus five percentage points.

Nichols describes many of Standard Life’s multi-asset clients as "sophisticated investors". Still, they are bound by legacy rules or lack the governance structure to enable them to invest in the more opportunistic fashion favored by many multi-asset managers.

Knutzen says multi-asset managers’ nimbleness means they can be opportunistic. So, he says, they "can make your money work harder." During the second half of 2014, as crude prices fell and oil company stocks and bonds plummeted, one of his department’s most successful plays was in high yield energy debt. The window to invest was short, and many institutions’ internal checks and balances meant that they couldn’t take advantage of the sell-off.

Not all state-owned investors are bound by lengthy approval processes. Increasingly, sovereign wealth funds, most notably the $21.5 billion New Zealand Superannuation Fund, are insourcing management and giving managers greater freedom to depart from their benchmarks. So-called strategic tilting frees the funds’ managers from strict portfolio allocations and provides the funds’ own staff with the freedom that Nichols says is enjoyed by multi-asset managers. Last week, Singapore’s $342.6 billion GIC increased its stake in duty free operator Folli Follie Commercial Manufacturing and Technical Group after its shares tumble on the Athens Stock Exchange on worries about Greece defaulting.

Timing Skills

Indeed, multi-asset allocations tend to fare better with more traditional funds that don’t have the internal capability for such investing. The Kuwait Investment Authority (KIA), has recently been working with BlackRock to determine whether to allocate to multi-asset strategies.

Often, a multi-strategy mandate is simply common sense, as in cases where a sovereign wealth fund doesn’t have the wherewithal to implement one internally. "One sovereign wealth fund we worked with was very keen to have exposure to multi-asset mandates in order to learn from those relations themselves and enhance their in-house asset allocation and portfolio construction process," says Meert. "It is for some investors a great way to keep in touch with the best talented asset allocation teams in the world and share knowledge."

Can these managers deliver outperformance? Cass Business School’s Clare is skeptical. "Given that markets in liquid securities tend to be efficient over time, the evidence suggests that managers don’t deliver alpha," he says. "When they do it’s doubtful that they add that much to investors’ returns net of fees."

In a recent study, written by Clare with colleagues from University College Cork, Ireland, he analyzed U.S., U.K. and Canadian multi-asset managers and concluded that the "asset class timing skills amongst multi-asset class funds is rare, existing only among a tiny minority of funds." That leaves open the question as to whether to allocate capital to the minority.

Job Training

Meert’s approach to multi-asset allocations for his clients recognizes the need to select managers carefully. "You need to perform due diligence in a professional way and know exactly what you want to achieve with this type of allocation in the overall portfolio," he says. "The selection process is absolutely key, as multi-asset managers do have very different investment philosophies and processes, which can give investors access to various sources of alpha they struggle to create internally." This, he says, explains why there is a small number of multi-asset managers that have attracted a lot of institutional capital.

Some believe the development of deep ties is important for the manager-sovereign wealth fund relationship. "These relationships make us better," says Lori Holland, managing director of multi-asset at Neuberger Berman. "Through this process we develop deeper insights." She cites so-called thought leadership exercises and joint research as examples of initiatives that foster cooperation. Kutzen, for his part, says that even the largest sovereign wealth funds want to partner to learn.

It’s an expensive form of on the job training. "Wouldn’t it be better to pay them a consultancy fee?" asks Clare. "Once you have a portfolio in the tens of billions, most managers will come flocking if you ask them. You don’t need to give these managers money to get access to their expertise."

Most of the major funds are siloed across traditional asset class departments, so the oversight of a multi-asset allocation presents a challenge. Regardless, if such mandates succeed in drawing outperforming investment gurus into the fold of sovereign wealth funds, it's an option well worth consideration.

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