Brick by brick: how a total return multi-asset strategy can enhance a portfolio

Building a portfolio of funds covering different asset classes does not guarantee diversification. Adding an allocation to a multi-asset strategy with a total return mandate, however, can help investors achieve superior risk-adjusted returns. Serge Pizem, our Global Head of Multi-Asset, explains how.

The traditional approach to portfolio construction for wealth managers and other fund-of-funds investors has been to blend strategies across different asset classes and trust that the resulting combination will provide suitable diversification.
In an age of higher correlations between asset classes, however, that may no longer be sufficient. Events in 2018 have demonstrated that the taper tantrum of 2013, when bonds and equities fell in tandem, was not an exceptional occurrence.
Most obviously, February’s spike in volatility blighted multiple asset classes. More recently, when in early October strong economic data in the US sent bond yields surging on the supposition that the Federal Reserve might start tightening monetary policy at a more aggressive pace, stocks wilted in sympathy.
Such correlations between asset classes at times of market tension should encourage investors to rethink how they protect clients’ portfolios.

“Fund-of-funds discretionary managers and institutional investors usually first define their long-term risk profile or long-term strategic allocation, and then they select the best strategy or the best manager for each of those single asset-allocation bricks”.
Serge Pizem, Global Head of Multi-Asset

-> Find out more about our multi-asset expertise:

• "Correlation conundrum: diversification in a strange environment"
• "Signals and noise: blending expert judgement and quantitative insight for superior multi-asset outcomes"

The advantages of flexibility

“But what I think the past 12 months have really shown is that such a static asset allocation puts your portfolio at higher risk, because in a volatile market everything can become correlated. So even if in theory you run a very diversified portfolio by asset class, this year has proved that everything tends to correlates when central banks normalise their policy. I think that is why we are now seeing an increasing appetite for total return multi-asset strategies, because they can bring more diversification to an otherwise static or less flexible allocation.”

For Pizem, a multi-asset total return strategy can enhance a broader portfolio’s diversification in three principal ways.

1. First, it itself will employ a flexible allocation policy – moving overweight or underweight different assets according to the prevailing market conditions. Importantly, this is implemented over a very wide universe of assets, not simply fixed income and equities.
2. Second, a multi-asset total return manager can deploy overlay strategies that are typically highly uncorrelated to broader market movements. One example that Pizem cites is the Japanese yen, which is often a reliable hedge against volatility in other equity markets. “That is an extra way to protect your portfolio when markets are difficult, which not only adds diversification but generates alpha too,” he remarks.
3. Third, multi-asset total return funds can hedge their portfolios against specific risks and events. Pizem recalls the value of doing so before the Brexit decision surprised the market. “You need to put in place such protection in order to anticipate the result of the referendum, or whatever the event is, because we know that equity hedges and out-of-the-money options can be very costly,” he says. “You can find other ways, though, for example by using the currency markets or by using geographical diversification to protect your portfolio.”

Of course, traditional single-asset managers – the longstanding bricks of a discretionary manager’s portfolio – will insist that they too can act pre-emptively and structure their positions more defensively when market risks are elevated. The problem for the end investor, however, is knowing whether those managers are really doing so.

Walking the talk

What distinguishes AXA Investment Managers in this endeavour is its ‘judgmental-augmented’ process, whereby robust quantitative inputs and analysis strengthen high-conviction judgements. Pizem and his multi-asset team are able to draw upon their library of 150 quantitative signals highlighting opportunities and risks in their universe of assets.

“Data analysis is really just a way for us to concentrate on the most important points and trends” says Pizem. “It’s really a judgemental investment process in the end, but the quantitative input enables our portfolio managers to focus on implementing three-dimensional portfolios based on our active views – moving overweight/ underweight different assets, using uncorrelated portfolio overlays, and hedging for risk mitigation. Fund-of-funds selectors, on the other hand, can only really go overweight or underweight different asset classes.”

Crucially, this ‘judgmental-augmented’ philosophy is entrenched in the team’s practice; they are not merely words.

“We have a very robust investment concept.I know it does not sound very fashionable, but we can prove that we are very robust. For any active bets implemented in the portfolio, we can demonstrate the macroeconomic rationale behind how we are invested – why we think it’s a good idea, why we’ve prioritised this idea, how we decided to implement it, and the best instrument for putting that strategy into the portfolio.”
Serge Pizem, Global Head of Multi-Asset

Pizem and his team tend to have around 15 high-conviction active views in their portfolios at any one time, each built on the foundations of data, insight, and process. This analysis is all assessed and verified by the team’s own fixed income experts, equity experts, macroeconomic researchers, and the Quant Lab of data experts and portfolio engineers.

“What makes us very different is that the multi-asset portfolio managers work closely with each investment platform within AXA IM,” says Pizem. “They can help with each active view in terms of the security selection, and portfolio management more broadly. There is no benchmark, so we can run very concentrated portfolios by selecting securities in an unbiased way to reflect the long-term convictions of the multi-asset team.”

Risk management boosts performance

Finally, risk management is a core component of everything the team does – and Pizem emphasises that that is demonstrable in the performance profile of the funds.

“We employ our judgemental-augmented process across our entire range of outcome-oriented multi-asset products, offering solutions for clients whether they are looking for growth, income, capital preservation, or inflation mitigation.”

“What I think is the most interesting aspect of that track record is how we manage risk in this portfolio,” Pizem points out. “When markets are up, we are in the first quartile. But when markets are down, we perform even better and are first decile. The combination of those two traits makes us first decile overall since launching this product. We are therefore able to prove that we perform very well when markets are down.”