Written By: Peter Fitzgerald
With sharp swings in asset prices even more likely following the UK vote to leave the European Union in June, Peter Fitzgerald of Aviva Investors examines how finding investment strategies able to deliver the outcome you need is crucial
In the aftermath of the shock UK vote to leave the European Union (EU) on 23 June and financial market convulsions unleashed as political risk rises, we face a prolonged period of heightened uncertainty. With valuations still looking stretched across major asset classes and more sell-offs likely to occur in coming months, consistently generating sufficient returns is tough. So, as pension scheme trustees grapple with reducing scheme deficits in such a stormy climate, a new approach to achieving the investment outcome needed may be called for.
Traditionally, trustees included equities in investment portfolios in the search for growth and bonds as a source of protection during turbulent times. However, in such times of elevated levels of volatility with anaemic growth in much of the developed world and negative interest rates in Japan and the Eurozone, this convention is challenged. It is little wonder that outcome-focused, multi-strategy investing is proving more popular in an attempt to provide sufficient returns to reduce funding deficits without compromising on volatility.
Multi-strategy funds invest across a diverse range of asset classes and strategies, including equities, bonds, currency, inflation, volatility and real estate investment trusts. While multi-asset funds are bound by asset allocation constraints, multi-strategy managers are free from such constraints and therefore have the flexibility to focus on the investment opportunity spanning across asset classes, regions and implementation instruments in their aim to achieve their performance and volatility targets.
Steady does it
Market returns are rarely smooth. And each percentage above or below the average annual target affects how much needs to be achieved to hit the objective. If assets fall in value then they need to perform better than average in percentage terms to meet the targeted long-term returns desired. The reverse is true when annual returns are better than expected.
For institutional investors who look to receive an income from their investments, the more the portfolio’s value drops the more the remaining assets have to work to provide the same annual income. Or, the higher the yield needs to be. So, the lower a portfolio’s volatility, the smoother the path to the end goal.
Building all-weather portfolios
Global equities plunged by 4.90%1 on 24 June, their worst daily fall since August 2011, in the wake of the UK vote to leave the EU. Even with a rebound over the following few days, equities are still -1.71%1 for 2016 following a 10.6%1 slide in the first six weeks of the year as concern around the prospects for Chinese growth intensified.
The Aviva Investors Multi-Asset Strategy (AIMS) approach targets long-term investment outcomes by aiming to produce steady performance irrespective of the investment climate, even when markets plunge. The AIMS funds combine three groups of strategies – “market”, “opportunistic” and “risk reducing”. Each plays a different role with their combination the key to helping funds achieve their objectives. The first group seeks to provide a positive return when markets perform as we expect, while the second looks to tap opportunities arising from market inefficiencies. However, the final one aims to boost returns when markets do not behave as anticipated without harming performance when they do. The aim is to combine these strategies in such a way that we can deliver the performance outcome desired for less than half the risk.
Risk-reducing strategies play a key role in seeking to stabilise portfolio performance during bouts of market stress. So one risk-reducing strategy looking to diversify portfolio risk aims to profit from US small-capitalised shares underperforming large-cap shares during times of market dislocation. Small caps typically underperform large caps during volatile periods, sometimes by a large margin. As exposure in the AIMS funds’ market strategies to equity markets is usually biased to large caps, this trade aims to limit potential portfolio losses caused by a sell-off.
Focused on long-term outcome
Any investment involves risk. Managing that risk is key to meeting objectives, especially as the uncertainty and volatility seen in markets over the last decade seems likely to persist in years to come.
By combining strategies with a focus on diversifying risk, multi-strategy funds look to provide steady performance that is uncorrelated with traditional asset classes. Indeed, it is during periods of market stress that the links and correlations between assets will become clear. With so much uncertainty around the UK, the EU and a US election in November to name but three, demand for multi-strategy approaches seems set to grow.
Derivative risks: As a result of the high degree of leverage typically employed when trading financial derivatives, a relatively small price movement in the underlying asset may result in substantial losses to the funds’ assets.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited “Aviva Investors” as at 28 June 2016.Any opinions and future returns expressed are those of Aviva Investors and based on Aviva Investors internal forecasts. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.
1. Bloomberg, MSCI AC World Local, USD, data at 29 June 2016