Traditional mixed-asset funds that invest solely in equities and bonds will find it difficult to generate reasonable returns in the current climate, says the Trojan fund’s Sebastian Lyon, who believes expensive valuations across both asset classes will weigh heavily on performance. There is a vast number of equity/bond portfolios across the UK market, with one sector – IMA UK Equity & Bond Income – packed to the brim with such products. The list includes some of the bestsellers in the entire IMA unit trust and OEIC universe, such as the £3.5bn Halifax Cautious Managed fund, the £3bn Newton Balanced fund and the £1.3bn Newton Managed fund.
Such funds are often seen as one-stop shops for anyone looking for a diversified portfolio – especially for pension investors – but Lyon (pictured) believes many people are set to be left disappointed in the coming years.
"In the past, bonds and equities were a good mix, as the risks of each offset the other," he explained. "Prior to 2008, the barbell structure worked very well. You could run a conventional balanced fund and do rather well."
"You can’t do that anymore, because yields are so low. Every asset that has a yield has big risks associated with it, so you can’t build a traditional model."
The manager believes inflation is a likely outcome of quantitative easing in the longer term, which would be particularly bad for bonds, but thinks that deflation is a significant possibility in the shorter term, which would be disastrous for equities in particular.
This, combined with expensive valuations, makes it next to impossible for traditional mixed-asset managers to protect investors against the downside, Lyon says.
"The bond market bull run has to come to an end at some stage soon," he said. "The downside risk compared with the upside risk is pretty phenomenally in favour of the former. If inflation comes into play, anything with a coupon will be disappointing for the next decade."
On equities, he added: "We’ve hit a period of an ever-increasing lack of risk aversion. My instinct is that from here, the risks are tilted more towards the downside than the upside. I wouldn’t want to forecast anything in the short-term, but looking at valuations from the top-down and the bottom-up, I don’t think there is much absolute value to be had."
Lyon himself runs a multi-asset portfolio, drawing on a much wider universe than just equities and conventional bonds. He uses commodities including gold, currencies, inflation-linked bonds and cash and cash equivalents in his portfolio, but admits that even he is finding it difficult to protect against the numerous headwinds on the horizon.
"In 2008, you could still find assets that offset each other," he said.
"Essentially, diversification worked – certain bonds offset equities and currencies offset currencies, which we benefited from particularly. With yields so low, it is now much harder to preserve wealth in the short-term. You need to have a longer-term time horizon."
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
The Trojan fund has underperformed both its IMA Flexible Investment sector average and FTSE All Share benchmark over one and three years. Its high exposure to inflation-linked bonds and gold – both inflation plays – has been costly, as has its 25 per cent weighting to cash.
"We’ve been increasing it because of the deflationary pressures we see in the shorter-term," he said. "Cash is the only thing that holds up in this kind of environment, which we saw in May and June."
Performance of indices May - July 2013
Source: FE Analytics
Asset classes fell across the board in May and June this year, on the back of speculation that quantitative easing could be tapered in the US. Some experts say that a cut-back in QE later this year, coupled with a rise in interest rates, could lead to a double crash in bonds and equities reminiscent of 1994.
Mark Dampier (pictured), head of research at Hargreaves Lansdown, agrees that it has become harder and harder for equity/bond managers to construct low-risk portfolios.
"I wouldn’t go as far as saying these traditional funds are outdated, but I think they’ll definitely go through a difficult period," he said.
"I completely see Sebastian’s point – if bond markets fall off a cliff, it’s not going to be good for equities either. If interest rates go up, everyone thinks bonds will get walloped, but it won’t be good for equities – not initially anyway."
"I think this is the most difficult time to give people advice in my 30-year career to be honest, because there’s nowhere to hide." Dampier even doubts the ability of multi-asset managers with wider investment universes to guide investors through these tough times.
"Arguably, all these do is give managers a bigger range of things to get wrong," he said. "In an environment where interest rates are going up, there are not many things that will do well – if any."
"People go on about commercial property making a comeback, but I can tell you now that won’t like gilt yields rising. It reminds me a bit of 2007 when you had all these managers saying they were diversified, but they still fell just as badly as everyone else."
"I can see a lot of low-risk investors in these kinds of funds getting really disappointed. We have a manipulated market and we don’t know how a lot of things are going to pan out. This is why I often think cash is overlooked – it’s the one thing you know isn’t going to get caned."
FE Trustnet will highlight some genuine multi-asset options for investors in an article later today.