Investors need to carry out more detailed research into multi-asset funds after many of these failed to offer portfolios some much-needed diversification in 2018. 
That’s the recommendation from the latest piece of research by Natixis Investment Managers, which found that multi-asset funds did not protect investors from the impact of volatile equity markets last year.
The Natixis Investment Managers 2018 Global Portfolio Barometer analyses the performance of 421 moderate risk model portfolios from financial advisers based in the UK, France, Germany, Italy, Latin America, Spain and the US.
According to the barometer, adviser portfolios across all regions delivered negative returns last year, driven by falls in equity markets. Over the course of 2018, the MSCI AC World index lost 3.79 per cent due to issues such as global trade tensions, slowing economic growth and tighter monetary policy.
Average correlations to portfolio of different asset classes, by region
Source: Natixis
Natixis noted that many advisers have been allocating more to multi-asset funds, in a bid to add diversification into their clients’ portfolios. “Many investors over the past few years have shifted allocations away from traditional equity and fixed income assets in to multi-asset funds, also known as allocation or patrimonial funds,” it explained.
“The promise of such funds is that professional managers will be able to pick the best opportunities across all asset classes and as a result provide a source of diversification whilst hopefully complementing advisers’ own portfolios.”
However, the firm added that multi-asset funds did not provide diversification as expected in 2018. Instead, they had “very high” correlations to adviser portfolios, which suggests multi-asset funds largely replicated what advisers were already doing themselves.
This can be seen in the chart above, which illustrates the average correlations of different asset classes to adviser portfolios. High correlations (which indicate low diversification potential) are in purple while low correlations and high diversification potential are in blue.
In the UK, multi-asset funds (labelled as ‘allocation’ in the table) had a 0.83 correlation with the average balanced adviser portfolio. This is the second lowest correlation in the research, but still represents quite low levels of diversification potential.
While Natixis believes it is clear that the average multi-asset funds is not providing much diversification, it asked whether they have been able to compensate for this by delivering high returns to portfolios.
The below chart shows the average returns in adviser portfolios for different asset classes last year. Natixis noted that multi-asset or allocation funds on average performed a little, but not much, better than equities.
Average 2018 performances of different asset classes within actual portfolios, by region
Source: Natixis
“In a year like 2018, it would have been great to have an investment that mitigated losses from equities and provided diversification to portfolios,” the fund group added.
“Allocation funds were not this investment. This is not to say that all such funds are the same but, in our opinion, advisers should be careful when using these funds.”
Of course, multi-asset funds were not the only investments to fail in protecting portfolios last year.
Geographical equity diversification offered little in the way of protection as most parts of the global suffered falls in 2018 given the macroeconomic nature of the year’s biggest headwinds. Fixed income or alternative strategies gave barely positive contributions at best.
The failure of non-equity asset classes to mitigate portfolio losses could offer some investors a reason to give up on diversification but Natixis added that it has not come to this conclusion and maintained that true diversification should be strived for in client portfolios.
“Many advisers sought diversification through multi-asset funds, which didn’t work in 2018. However, many of these funds simply replicate what the advisers are doing themselves, and as a result have very high correlations to adviser portfolios,” the research concluded.
“When we compute the diversification benefit of all the portfolios in our sample, we find a strong negative correlation with portfolio risk, and a moderate positive correlation with returns.
“That is to say that the most diversified portfolios had lower risk and higher returns than the least diversified portfolios. Advisers with truly diversified portfolios fared much better than those with only pseudo-diversification.”
Performance of UK multi-asset sectors vs equities and bonds in 2018
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Source: FE Analytics
In the UK, the average fund in three of the four Investment Association multi-asset sectors failed to outperform global equities last year. While the MSCI AC World was down 3.79 per cent, the average IA Flexible Investment member dropped 6.72 per cent while IA Mixed Investment 40-85% Shares fell 6.11 per cent.
Natixis does not say this suggests investors should be avoiding multi-asset entirely, only that they need to be more mindful of the multi-asset funds they are adding to client portfolios.
“Of course, there are some fantastic multi-asset funds available, but investors need to check whether those that they invest in are truly diversifying their portfolios, or just ballast where they are paying management fees for what they could do themselves,” it said.
“In fact, we have seen many advisers reducing allocation to these funds in 2018 in recognition of this fact.”