There is one statistic that I hear a lot in our industry and it reminds me of the joke that 83.7% of all statistics are made up. Except it wasn’t invented, it was born out of past research, but it was stretched so far from its original source that it just might as well have been.
The statistic is that “90% of returns come from asset allocation”. I could criticize the original article, but that wouldn’t matter. Statistics have been so carefully laundered now that they alone constitute a fund management “truth”. Except that is not true. Not in the context where most people use it, anyway.
In this context, given that “asset allocation determines 90% of returns”, we, the fund managers, must devote 90% of our efforts to defining the asset allocation of our fund.
This is more common in the world of multi-asset funds (i.e. my world), where asset allocation is, naturally, more of an issue than in, say, a UK equity fund.
This is a bait and a switch. It may be fair to say that 90% of returns are driven by asset allocation, because a 100% cash portfolio, for example, will have nothing to do with a 100% equity allocation. But that’s different from saying that 90% of a multi-asset fund’s returns should be driven by the manager’s asset allocation decisions.
When a manager uses the statistic of 90% to broaden his investment process, he is generally referring to his ability to use “macro” decisions to outperform his peer group, or a blended benchmark, or them. of them.
And this is a relative decision, not an absolute one. Very few funds have the full flexibility to go from 0% stocks to 100%, so they are not really allowed to make decisions that will dictate 90% of a client’s returns.
This is where it gets personal. At least he should do as the only people who have the capacity to influence 90% of an individual’s actual performance are that individual or their financial advisor. And it is as it should be.
Strategic asset allocation is the key
Everyone is different. We each have a unique set of personal financial circumstances. So you should have your own unique asset allocation. This includes not only how much of your wealth is invested in a multi-asset fund, but all of your personal assets, including your house, your money, and that ugly, but possibly precious, vase that Great Aunt Beryl passed on.
This is a “strategic” asset allocation. This means it’s semi-permanent, with changes dictated only by what’s going on in your life: aging, dramatic changes in wealth, modified retirement plans, children, etc.
This is the asset allocation to which the 90% statistic should refer. And it is a job as a financial advisor, not a job as a multi-asset fund manager. How can that be? Our funds are held by thousands of different individuals, and we are not a party to any of their personal data.
So this 90% statistic, and this is my real bogeyman, is only for individuals and their advisors. It should not be used to justify the macro top-down investment process of a multi-asset fund. We are never in a position to influence nine-tenths of an individual’s actual total returns, only the returns of the tranche they gave us.
And we’re unlikely to have 90% influence on that either, as we’re limited by factors like sector asset limits.
In other words, the 90% statistic is used to justify the use of top-down decisions (as opposed to bottom-up stock and / or fund selection) as the primary means for a fund to outperform its peers or an index of. reference.
Don’t bet on macro calls
But here’s the catch, and a lot of people will hate me for saying this, from an investment standpoint, top-down decision making doesn’t work.
Not systematically, anyway. Yes, it is possible to get an individual macro call correctly. Say, for example, you reduce a fund’s equity exposure from 80% to 60% just before a sell-off and it’s powerful when we do. Not 90% powerful, but powerful enough to make a big difference in relative performance (for better or for worse).
Unfortunately, there is no evidence to suggest that this is a repeatable skill, and many suggest it is not. Rather, it’s a matter of luck, which makes it even more dangerous. Making one or two macro calls inflates the ego, making us think that we are probably going to make the next good too, and therefore bet more on that call.
It makes it more painful when we inevitably get a bad call in the future.
If I’m right about this, then by making asset allocation changes, especially big macro-driven changes, multi-asset funds cause two problems. First, we needlessly increase the risk of costly investment error. Second, we make life for investors more difficult by constantly moving away from the strategic makeup of their chosen asset allocation.
In a previous column, I mentioned the emphasis the Vanguard funds put on Terminator on doing what they said they would do. I think it’s an overlooked feature of their popularity that is killing categories.
Particularly in mixed asset sectors, where their Life Strategy funds are becoming dominant. Investors like their portfolio to still be invested in the same mix of assets in three, five or 10 years, which gives them more control over their portfolios.
Particularly compared to a fund which, on the basis of a false macro intuition, significantly changes its asset mix.
Now if you know me, you will be surprised to hear what sounds like a sales pitch for passive funds. Rest assured this is not the case, it’s just that in order to beat a strong opponent you need to study and understand their weaknesses and strengths. Besides cost, the main strength of passive funds isn’t getting sucked into market timing decisions that destroy value, which is essentially what most macro calls are.
So what are the weaknesses of tracker funds?
Most are overly exposed to large, bulky companies just by following a clue. By owning everything, they own too many shoddy stocks, too expensive stocks or both, let alone being blind, or at best awkwardly selective, to corporate ethics and behavior. It is here, and not by market timing, that they can be beaten.
Unfortunately, due to the necessary, but exaggerated, focus on cutting costs, more multi-asset funds are competing with Vanguard where they are strong, trying to overtake them in a timely manner. While fewer take the time to research and select good individual investments because it is more difficult and therefore more expensive work. But, if it’s done right and billed fairly, this is the bit that actually works.
This is something that the brave people of the Vanguard understand only too well. That’s why, for their active funds (yes – they also sell active funds), they outsource management to excellent bottom-up, not macro stockpickers. That’s why they use Baillie Gifford and Marathon for the Vanguard Active UK fund.
It may not be a coincidence that Baillie Gifford Managed, which focuses on bottom-up stock selection without macro-betting, is one of the few funds to outperform Vanguard funds in the IA Mixed Asset sector 40% at 85%: If you can’t beat them, hire them.
So here Vanguard and I agree – either go completely passive, including asset allocation, or if you think it’s possible to do better, in terms of returns or ethics, or both. , which I do, then focus on finding some great bottom-up managers. .
Everything else is, statistically speaking, likely to end badly.
Simon Evan-Cook was previously a Citywire AAA-rated fund manager at Premier, and is now an independent fund analyst. He blogs on Nevermindthesilverbullets.com
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