Mark Harries, head of multi-manager at Cazenove, explains how investors need to learn to think in a new way to ride out this period of volatility
The rollercoaster markets of the past few weeks have left investors with a familiar giddy feeling. Can it really have all come full circle again so quickly? Whether it is a market 'correction' as most assume, or something more significant, it is fair to say that most investors and their advisers could do without the headache. Investors could also do without the worry that their investments, having dipped a toe back in the equity market, will fail yet again to achieve their lifestyle goals. Equally, worried phonecalls from clients seeking reassurance will just add pressure to the situation. Is there another way?
The introduction of the COLL legislation has made multi-asset portfolios an investment reality. Retail investors now have access to investment strategies that have existed in the private client world for many years. But can these strategies protect investors against the rollercoaster ride of the global markets? And if so, how do they do it? (See chart one).
Diversify your risk
This chart is well used, but it illustrates an important point. Investors selecting the top performing sector in any given year are likely to come unstuck the following year. Some multi-managers will aim to predict these trends. This can be profitable when it goes right, but if investors are looking for a sleep-at-night portfolio, this is not likely to provide it. Generally, the consistency is not there and it is difficult to get it right over the long term.
A second problem that has arisen in recent years is that volatility indicators are a less reliable indicator of risk. When all markets are rising, volatility tails off and loses its predictive potential. Therefore, an adviser can be mis-led when selecting funds on risk-adjusted performance. Corrections in the market could hurt even more if an adviser has not properly diversified client portfolios through a poor understanding of risk.
We at Cazenove believe that if we can achieve 80% of the profits in rising markets and just 20% of the decline in falling markets over the medium term (around three years), we can significantly outperform over the longer-term. This is illustrated by chart two.
But this is still fundamentally against the mindset of many UK investors, who want to be in the top performing asset class at all times. Investors need not panic when they are up 30% and the equity market is up 40%. Capital preservation is key and will create greater wealth over the long term. The Cazenove Multi-Manager Diversity Fund has a medium-term performance target of CPI + 4% per annum.
Lasting the distance
The 20% protection on the downside cannot be achieved by an equity strategy alone, although the inclusion of long/short equity funds will help. We believe in strategic asset allocation rather than an aggressive tactical mix. The Diversity fund, which sits in the Cautious Managed sector, is split into different asset classes as shown in chart three.
This seldom changes. Holdings will be trimmed back if they have got too high or added to if too low. A recent example was the JPM Natural Resources fund, which was cut back from 6% of the fund to 3% following good performance. Cazenove believes in mean reversion, so swapping between asset classes will ultimately prove fruitless. Investors often get sucked into the market at the wrong time and tend to buy from the latest numbers, forgetting that these phenomena do not happen every year.
Ultimately, suffering volatile equity markets is a choice. If investors are willing to accept a lower proportion of the upside, they can immunise themselves, to some extent, from declining markets. Cazenove Multi-Manager Diversity is one of an increasing number of products that is successful in this. Investors need to start thinking in a new way.
£116.8m of benefits received by customers
Spent 13 years at JPMAM
Headed by Ben Palmer and Edward Park
Consults on regulation and innovation in green finance
13 studies begun since April 2013