A “mislabelling” of assets within multi-asset funds is exposing investors to greater risks than they realise, according to research from Asset Intelligence.
The majority of multi-asset funds are placed in one of three Investment Association (IA) sectors, which are defined by their exposure to equity markets; namely the IA Mixed Investment 0-35% Shares, 20-60% Shares and 40-85% Shares sectors.
But according to Asset Intelligence, this overlooks the exposure to other risky assets, such as emerging market debt (EMD), which are counted towards the fixed income exposure of multi-asset funds, but could be considered in the same risk risk category as equities.
“Assets such as high yield and EMD are fixed income assets and therefore don’t count towards the equity allocation of funds, but evidence shows they correlate closely to equities, particularly in periods of market stress,” said Robert Love, head of research and principal at Asset Intelligence.
If two assets have an expected correlation of 1.0, it means they are perfectly correlated, so if one gains 5% so will the other, and vice versa if they drop in value.
Lack of protection
According to Asset Intelligence, with a correlation of 0.77 and 0.79 respectively for local and hard currency EMD to global equities, as defined by the MSCI All Countries World Index, and 0.84 for global high yield bonds, allocating to these assets in the expectation they will offer real diversification if equities sell off shows a major flaw within multi-asset funds.
“By leaving them out of the fund’s ‘risk’ category it means investors are left exposed to assets which will act more like equities but which they assume are offering them protection,” said Love. “This is a poor outcome for clients who won’t know what risks they are really exposed to.”
Chris Metcalfe, investment and managing director at Iboss, agrees with the Asset Intelligence research stating it is something they have long warned their clients of.
“High yield bonds have equity-like risk with the potential of meagre returns,” he said. “You might as well hold the equity.”
A definition problem
To additionally reduce fixed income risk, Metcalfe said the Iboss multi-asset funds never chase yield, while they also currently have the shortest bond duration across its fund range and the highest credit quality.
“We also have genuinely diversified equities,” he added. “For example in GEM we hold four funds which can, and do, behave well at different times, rather than hold several versions of the same thing.”
For Asset Intelligence, part of the problem stems from the IA sector definitions, which categorise funds by their exposure to equities, not other assets – however equity-like they be.
“Many multi-asset funds include many different asset classes, but by mislabelling these assets, they have been making investments in the part of their portfolio considered to be defensive, only to find it is anything but,” said Love.
He added: “It was a nice marketing idea to put a collection of assets into one fund and call it portfolio management, but the reality is that in many cases multi-asset funds offered to advisers and their clients don’t offer investors the risk profile they think they do.”
