In her latest monthly review, Gill Hutchison shows how the variety of asset allocations in what used to be the Balanced Managed sector highlights the importance of making a suitable choice for clients' risk appetite
In May's review of the Investment Association (IA) Mixed Investment 20-60% Shares sector, we discussed how the (then) Investment Management Association reviewed and made changes to the mixed sectors back in 2012. The IA Mixed Investment 40-85% Shares sector loosely corresponds to the old Balanced Managed sector.
The observations we made about the broad nature of the 20-60% sector equally apply to the 40-85% fund grouping. Quite plainly, when the equity allocation within a single sector can range between such wide boundaries, there is scope for a host of different outcomes. This also reinforces the danger of using the sector average as a benchmark against which to measure the success - or otherwise - of a fund's relative return.
The strength of fixed income markets, as rates have fallen and stayed low since the financial crisis, has served to mask the potential for varied outcomes from funds with different asset allocation splits. Illustrating this last time, when we looked at three dummy portfolios that incorporated a simple split of UK equities and gilts - with 85%, 60% and 40% in equities - the differences in returns between them, when looking at a five-year period since May 2011, was minimal.
The past year is, however, more illuminating. With the UK market hitting a high of a little more than 7,000 on the main index just over a year ago, equities have clearly been on a weakening and volatile trend ever since. Meanwhile, gilts have been a useful offset to equity risk, as investors have sought out ‘safe havens' in the form of sovereign bonds. Yields have also fallen because of a growing acceptance of the idea that interest rates - at least in Europe and Japan - are likely to stay low for even longer, as sustained growth and inflation remain elusive.
This backdrop sees much more meaningful differences between our three dummy portfolios, with a fall of more than 6% for the 85% equity version, compared with a -3% return for the 60% equity version and a slight positive return for the 40% equity portfolio over the past year (all data is from Morningstar Direct, to 23/5/16).
This brief analysis reinforces the importance of making a suitable choice for your client's risk appetite and giving careful consideration to a fund manager's sphere of activities - particularly in relation to asset allocation.
Like the other Mixed Investment sectors, it is not possible to cite a typical asset allocation for the sector in aggregate, and equity weightings can reside across the full 40-85% range - although, in practice, fewer reside in the lower reaches of the band.
This also means that many funds are a fair distance away from the original concept of ‘balanced', which was one very good reason to change the sector name! Indeed, risk assessment processes would suggest the majority of the funds in this sector are suitable for more adventurous investors and/or those who have the luxury of a longer investment time horizon.
Strategic or tactical asset allocation?
Assessing a fund's asset allocation profile and the extent to which the boundaries are tested are critical elements in weighing up a fund's suitability for an investor. While tactical asset allocation sounds appealing, our experience is that funds with a structural asset allocation framework are often more effective in the long run.
They are certainly more user-friendly for investors, most of whom are seeking some confidence in the expected outcome. The ‘Trust me, I'm a doctor; version of the world is over and all managers must be in a position to articulate the expected customer journey with clarity.
With 134 funds, this sector is similar in size to the IA Mixed Investment 20-60% Shares grouping. The largest fund in the sector by far is the BlackRock Consensus 85 fund, which is a low-cost offering that is invested in a range of BlackRock trackers. Its success speaks to the appeal of simple propositions, particularly in the guise of default fund options.
Vanguard has also garnered assets with its LifeStrategy range and two of these funds reside in this sector - the 60% Equity and the 80% Equity funds, with combined assets of more than £2bn. Jupiter Merlin Balanced is a stalwart of the sector, with a fund size of £1.5bn (All fund sizes as of 13/5/16, source: Investment Week).
Within The Adviser Centre, we currently feature two funds from this sector, AXA Framlington Managed Balanced and Fidelity MoneyBuilder Balanced. Both funds are traditional in nature and reasonably priced.
AXA Framlington Managed Balanced is managed according a steady asset allocation framework, with equities weighted at 70% to 80% through time. This puts it at the upper end of the range of equity exposures in comparison with other funds in the sector. The equity portion is biased towards UK equities and the fixed income/cash portion of the fund is designed to offer an offset to the equity risk.
Jamie Hooper, co-manager of the fund overall, runs the UK allocation while the overseas equity portions are managed by other internal managers at AXA Framlington. Overall, there is a growth tilt to the equity managers' styles and this shows through in the fund's return profile.
Recent months have seen some change to the management of the fund, with longstanding manager Richard Peirson preparing for his retirement in March 2017, at which point Hooper will become the lead manager. We have retained the fund's ‘Recommended' status based upon our knowledge of the individuals in the team who contribute to the fund and the relative simplicity of the fund's structure.
Fidelity MoneyBuilder Balanced is also biased towards equities, albeit to a lesser degree, and it is primarily invested in UK assets. It is managed by two experienced and highly regarded investors - Ian Spreadbury, who manages the bond portion, and Michael Clark, who runs the equity portion.
As we say in our factsheet on the fund, its beauty is in its simplicity. The asset allocation is set at 65% in equities and 35% in UK fixed income and deviations from this framework are marginal. The fund pays out a monthly dividend and thus income generation is an important focus.
Clark manages the equity portion according to his successful UK equity income approach while Spreadbury's fixed income portion is conservative in nature, recognising its primary role as a complement to the equity component. We see this fund as a cost-effective way to access a straightforward, income-focused equity and bond fund. It is suited to investors who are seeking a monthly income but are uncomfortable with the volatility associated with pure equity exposure.
Gill Hutchison is head of investment research at City Financial. To access the firm's free-to-air fund research and consultancy service, visit www.theadvisercentre.co.uk
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