Can multi-asset funds protect you from market shocks?

Sponsor’s position paper by David Vickers, Russell Investments

Multi-asset funds have become increasingly popular among investors who want to focus on a specific objective rather than on beating a stock-market benchmark. Casey Quirk, a management consultant focused on asset management, recently forecast there will be more than $3 trillion of demand for multi-asset and benchmark-agnostic strategies worldwide between now and 2020.

Multi-asset funds will not give you immunity from market shocks, but the better funds can help you mitigate them through skilful management. That requires a number of key competences:1. A robust investment process that can help navigate changes in market values, business conditions and investor sentiment 2. Thorough preparation for risk events through effective portfolio diversification 3. Real-time monitoring of the portfolio and markets 4. Comprehensive risk analysis at the total portfolio level and constant re-evaluation of risk/ reward pay-offs 5. Expert trading skills to implement new ideas quickly and cost-effectively.During 2016, in our own multi-asset funds we have relied on all of those competences to navigate a challenging start to the year. I describe our experience, and our action around Brexit, in more detail below.Risk mitigation strategies – the background Global risks have been on the rise for some time. The first step in risk mitigation is to assess their probability and likely impact. At the turn of the year, our investment process delivered a sober evaluation, based on our three assessment factors – cycle, valutation, and sentiment (CVS):• Business cycle: Our research showed that growth had slowed and world economies were struggling to regain momentum. • Market valuation: We knew most developed markets were expensively valued. An expensive market is by definition a risky market and prone to shocks. • Investor sentiment: Our technical indicators showed that the primary uptrend for equity markets had broken down when the US interest rate cycle started to turn in late 2015.Against that background, we entered 2016 with our multi-asset portfolios in defensive mode, with relatively low equity exposure and relatively high cash and Treasury bond holdings. We had also diversified extensively across different asset classes and strategies that we believed would be more resilient in a risk-off environment. These investments included infrastructure, absolute return strategies, convertible bonds and volatility management strategies. Lastly, we had put in place derivative protection strategies that provided us with some protection against market falls from higher levels and would increase our equity exposure if markets were to become more attractively priced.In the New Year, equity markets started their worst January sell-off on record. We continuously monitored developments as our CVS process guided us to add back some equity exposure; this led us to put in place a new call option strategy as markets bottomed around 11th February. This strategy replaced our previous US equity sales with new synthetic exposure. To finance the cost of the trade we sold part of the upside at the 1900 level on the S&P, and committed to buy additional exposure if the market fell to 1650 (which was our fair-value target level). The prevailing option pricing meant that our sale of put options at the 1650 level allowed us to buy roughly twice as many call options on the US market (7.8% versus 4%, or 1.8x).That sequence of actions illustrated our focus on three key attributes of multi-asset investing: dynamic allocation, effective diversification and downside protection. Those attributes came back into play as we approached the June European referendum.