An unprecedented level of global economic volatility is paving the way for a new generation of multi-asset strategies, according to UBS Australia and New Zealand head of investment strategies Tracey McNaughton.
McNaughton presented her insights on the new ‘norm’ of volatile markets during one of Netwealth’s monthly educational webinars for financial advisers. McNaughton has nearly 20 years of experience in the investment industry, having held senior roles at Colonial First State Global Asset Management, Baillie Gifford and BT Financial Group.
“We live in interesting times,” McNaughton stated boldly, noting that “we never thought we'd see the day where bond yields can go negative, and we never thought we'd see the day where a reality TV star could become the president of the United States.”
It’s an environment where there has been a depletion of political capital following the GFC and a rise in discontent. Beyond that, central banks have taken on an "asset management" role, given that, as McNaughton argued, "the sheer act of quantitative easing implies that the central banks are loading up on assets such as bonds – and in the case of Japan, they're loading up on equities as well."
The age of moderation
As a result, investment strategies need to evolve. To illustrate this, McNaughton compared the current state of global markets to the 1990s, which she described as “the age of moderation” – it was a time when (from around 1987 to the early 2000s) economic growth was high and volatility was low. Then-US president Bill Clinton took a "chainsaw to financial regulation" by repealing the Depression-era Glass-Steagall act, which restricted commercial lenders from engaging in investment business, oil prices were averaging around $35 a barrel, drawdowns were rare and bonds were returning almost as high as equities compared to the long-run average of 2.6%.
These conditions led to fairly basic "set and forget, buy-and-hold" investment strategies, where the primary focus was on two major asset glasses: equities (mostly domestic) and bonds. The prevailing industry philosophy prioritised manager selection over asset allocation.
This is no longer the case. The importance of diversification has become increasingly important; as evidence of this, McNaughton cited Towers Watson research which showed the average allocation to alternative assets rising from 5% in 1995 to 20% today. Asset allocation is no longer decided “once a month around a table by all the individual portfolio managers,” and returns are no longer high enough to justify “spreading out the fee budget” outsourcing to multiple different managers, as was the case with early multi-manager diversified funds. Investment manager costs have become a far more important factor than they were before.
The end of set-and-forget
Fee concerns have caused investors to move away from multiple single-sector managers towards a smaller amount of multi-sector ones. On top of that, there are now many more asset classes to manage – real estate, hedge funds, private equity, infrastructure, and so on – and hugely increased volatility in equities means “setting and forgetting” is no longer a feasible policy.
All of this has prompted multi-asset strategies to evolve further; as McNaughted noted, “A number of changes have been made: each building block is managed in-house increasingly to conserve the fee budget. There’s an increased use of derivatives; asset allocation is no longer monthly or fortnightly or weekly; it's now bi-weekly and it's being looked at every single day.”
The in-sourcing of asset allocation has triggered an expansion of in-house investment teams, and low returns have shifted investor focus away from generating alpha to minimising costs wherever possible. The rise of exchange-traded funds (ETFs) has facilitated this, reducing active management fees by “actively allocating” to a diversified selection of passive strategies and increasing liquidity.
In other words, McNaughton said funds are building more efficient portfolios by “improving the design of the multi-asset fund while still maintaining an active asset allocation over the top of it.” In the case of the UBS Tactical Beta Funds, this involves breaking down asset allocation into further sub-categories investment grade and high-yield bonds, Australian bonds, REITs, bank loans, infrastructure debt, international and domestic equities and currency.
At the same time, though, McNaughton added that the majority of risk and return, given the overarching similarity of this strategy’s “basic building blocks” to a traditional balanced fund, comes from the benchmark. In order to get beyond this, she said it was time to move into “unchartered territory.”