The overwhelming conclusion of The Great Guide to Risk-Rated Multi-Asset Funds, is that most multi-asset managers have no asset allocation, manager selection or risk management expertise worth paying for. Judged against simple low-cost equity-bond portfolios constructed by a novice investor (dubbed ‘Brainless Portfolios’), most multi-asset funds systematically damaged returns on a risk-adjusted basis and reduce the chances of an investor meeting their return objectives.
For our analysis, we created 5 ‘Brainless Benchmark Portfolios’ made up of percentage allocation to two asset classes – global equities and global bonds – as shown in the chart below:
The Brainless Portfolios have an annual fee of 0.50%pa and are rebalanced once a year on the 1st of January. The Brainless Portfolio is a passive portfolio in its purest form that allocates to market cap-weighted global equities and bonds, depending on the degree of risk an investor is prepared to stomach. In other words, they would take whatever return the market gives them rather than trying to make active predictions about which assets will perform better than others.The ‘Brainless Portfolios’ depict the baseline return investors should expect for investing in a risk-based portfolio because it doesn’t require any asset allocation or manager selection expertise. The only asset allocation decision our ‘Brainless Benchmark Portfolios’ require is what proportion of their portfolio should be invested in global equities and global bonds. They simply rebalance once a year on the 1st of January. And that’s it.
No tactical decisions. No allocation to property, commodities, alternatives or any other fancy stuff.
The question we aimed to answer is, how do portfolios constructed by expert fund managers, asset allocators and Masters of the Universe compare with our brainless portfolios?Well, here’s how…
These scatter charts plot the cumulative return against the risk (volatility) of multi-asset funds. Each dot on the chart represents a fund. A polynomial trendline shows the risk-return relationship between all the funds in the same fund range. Each trendline on the graph represents an entire fund range, which consists of all the individual funds that make up the range. We refer to this trendline as the ‘Efficient Frontier’ for each fund range.
Fund ranges that lie below the ‘Brainless Benchmark Portfolio trendlines are sub-optimal because they do not adequately compensate clients for the level of risk associated with the fund. Portfolios that cluster to the right of the ‘Brainless Benchmark Portfolio’ trendline is also sub-optimal, because they take higher levels of risk for the level of return they deliver i.e. clients are taking more risks to get less return.The Empirical Foundation for Brainless Portfolios
The Brainless Portfolio is based on the concept of The Global Multi-Asset Portfolio (GMAP or Global Financial Asset Portfolio) which represents how the markets across the world allocate capital across publicly traded financial assets. The concept of GMAP has been covered extensively in academic and practitioner research, notably by Ronald Doeswijk et al in his paper titled The Global Multi-Asset Market Portfolio, Meb Faber in his posts and book titled Global Asset Allocation and by Cullen Roche who noted in recent article that;“The global multi-asset market portfolio contains important information for strategic asset-allocation purposes. First, it shows the relative value of all asset classes according to the global financial investment community, which one could interpret as a natural benchmark for financial investors. Second, this portfolio may also serve as the starting point for investors who use a framework in the spirit of Black and Litterman (1992), or for investors who follow adaptive asset-allocation policies as advocated by Sharpe (2010).”— Ronald Doeswijk et al, The Global Multi-Asset Market Portfolio“If there was such a thing as an indexing purist that person would simply buy all of the outstanding available financial assets in the world and call it quits. In other words, they would take what the market gives them rather than trying to make active predictions about which parts of the financial asset world will perform better than other parts.”— Cullen Roche, Is the Global Financial Asset Portfolio the Perfect Indexing Strategy?
The Brainless Portfolio is neutral; it’s how a novice investor should approach investing. Without any asset allocation expertise, a starting point should be to allocate their capital based on aggregate global market, and so it’s a perfect benchmark for multi-asset funds.The Curse of Home Bias
This brings me to the next point. A few people criticise the Brainless Portfolio because ‘most multi-asset funds would have more allocation to UK equities.’
This misses the point. Deviating from the cap-weighted global equity allocation presumes that you know better than the aggregate of investors across the world. UK multi-asset fund managers exhibit home bias by allocating more to UK equities, presumably because they have carried out thorough analysis about how best to allocate investors’ capital. And they know better than the markets. They can choose any asset class they want – commercial property, commodities, whatever. This is where their expertise lies; since the proof of the pudding is in the eating, this should result in higher risk-adjusted returns. Except it doesn’t.To Hedge or Not to Hedge a Global Portfolio
Another criticism of the Brainless Portfolio is that it hedges currency back to Sterling. The rationale is that, as a UK investor, you presumably earn and spend in Sterling. And so, while you are keen to benefit from the returns and opportunities offered by the aggregate publicly traded financial assets across the world, you are not prepared, as a novice investor to take currency risks.
So it makes perfect sense to me that a novice investor, using the Brainless Portfolio would take currency risk off the table by hedging back to their local currency. If not entirely, some of it. This is why many global bond funds offer a GBP hedged share class.
UK multi-asset managers are ‘experts’ and they make an informed decision to take currency risk. This adds another tool to their armoury, and since the additional currency risk should be rewarded, this is yet another reason why multi-asset funds should outperform the Brainless Portfolios. Except that, they don’t.
In summary, given we are all living longer, we are having to save for retirement and most face prospects of having to spend less in retirement, the least asset manager can do is to earn their crust!