Using multi-asset solutions

While many of the arguments of this debate are well-rehearsed and known by investors, they typically relate to using passive funds as a single asset class exposure within a portfolio.

Less understood are the implications of using passive multi-asset solutions.

While multi-asset strategies are quickly gaining traction among advisers and share many attractive features with their single asset class counterparts, they also pose challenges for investors.

This is due, in part, to the fact that the debate is focused on the future, which is inherently unknowable and consequently subject to conjecture.

It may also reflect a resistance to change – in part biased by longstanding conflicts of interest – with a perceived threat to business models and even the self-worth of active managers.

However, before sounding the bell to signal the death of active management, it is worth investigating the source of the performance that has driven the growth of passive funds to the top of the league tables.

As we do this, it is important to note that some of the logic that underpins the advantage of passive funds in the single asset space no longer applies.

For example, while it is a truism that the returns of a well-structured index must reflect the total returns of all participants (plus costs) in a single asset class context, the same is not true when operating across asset classes.

This is because the primary differentiators of a multi-asset fund – especially the split between equities, bonds and cash – typically reflect a risk preference set by the fund manager rather than the relative market capitalisation of those assets.

The rise and rise of passives

Before focusing on quality of the passive ‘basket’, it is worth reminding ourselves why passive investing has become so popular over the past few years.

While much research has been written about the historic relative returns of active vs passive, the more important debate is which strategy is likely to deliver better returns in the future.

In this context, passive funds have several key advantages, most notably the fact that they typically offer lower-cost exposure to an asset class, reducing the drag that fees exert on returns.

In addition, passive funds avoid the investment mistakes that frequently occur when active managers run portfolios.

For the fund selector, passive funds also help reduce the behavioural biases associated with picking managers, especially our natural inclination to buy funds that have performed well and sell those that have not.

In this guise, passive funds have delivered excellent returns for investors, with several passive strategies placed near the top of their relevant Morningstar category over the past five years.

This combination of low cost and strong performance is undoubtedly attractive and is fast becoming the default investment choice of many advisers keen to focus on financial planning rather than fund selection.