Funds that smooth the highs and lows

A multi-asset investment strategy can reduce the sometimes alarming effect of stock market fluctuations. So, how does it work?

There is one very simple rule that everyone must understand before investing their money: despite claims to the contrary, no one can ever be 100 per cent certain which asset classes will outperform over different time periods.

Equities may well be the star performer in some environments, while corporate bonds will shine in others. It all depends on global stock markets, economic conditions, political factors and the skills of individual fund managers. Analysis by Morningstar proves the point.

The average fund in the IMA Global Emerging Markets sector grew by 35 per cent in 2007, but fell by a similar amount the following year. The IMA High Yield sector, meanwhile, lost almost 30 per cent in 2008, but rose by nearly 50 per cent last year.

What can investors do?

According to David Wells, head of Pensions Investments and Savings at HSBC Bank, the answer is to hold a variety of assets, the idea being that as one goes through a rough patch, others will hopefully be rising in value to compensate.

"If you want smooth returns, it makes sense to hold a portfolio of non-correlated and geographically diverse asset classes," he says. "These can include commodities, hedge funds, private equity and property, as well as traditional equities and bonds."

An increasing number of investors are using multi-asset investment strategies as the core holding in their overall portfolios as a way to reduce potential volatility and enhance returns, says Andy Gadd, head of research at Lighthouse Group. "They are probably not suitable for very low risk investors but could fit higher risk investors that want to take a core and satellite approach," he says. "The crucial factor is ensuring it is appropriate for the level of risk that an individual wants to take."

Generally a broad allocation starts with a mix of the four main asset classes of equities, bonds, property and cash holdings. Other asset classes, such as commodities, can be added into the mix.

Further diversification is possible through sector and geographical exposure. For example, an investor may opt for investments in Japanese Smaller Companies, as well as international firms involved in technology businesses.

Build it yourself

There are two ways to embrace the multi-asset approach. The first is the "Do It Yourself" method, whereby you buy a variety of assets and funds. The second is choosing a specialist fund and let its manager make the choices on your behalf.

According to Justin Modray of website Candid Money it is quite straightforward for retail investors to construct one by using a combination of unit trusts, investment trusts and exchange traded funds. "I'd suggest investing in global stock markets – including emerging markets, as well as corporate bonds, commercial property, commodities and absolute return funds," he says. "A mix reduces the possibility of big losses."

The amount of exposure to each asset class will depend on the investor's goals and risk appetite. Those that want higher returns, for example, will probably have a lot in racier global equities, while the more cautious may keep the bulk in bonds.

Of course, managing your own multi-asset portfolio is hard work. Not only must you keep on top of what is happening in different asset classes, you will also need to bear in mind the various economic and political factors that may influence future returns. That is why research is vital. Before making any investments you will also need to know about the track record of any managers whose funds look attractive, says Modray.

"The biggest downside to doing it yourself is the possibility of making costly mistakes," he says. "If you inadvertently take too much risk or pick the wrong funds then you could well end up losing money."

So although it is possible for private investors to put their own portfolios together, it is certainly not a job for the faint-hearted – and can also be full of potential risks, warns Geoff Penrice, a financial adviser with Honister Partners.

"Given the range and complexity of investment markets, and because investment conditions can change very quickly, I'd use a professional to run both my own and my clients' investments," he says.

Specialist funds

Fund management companies have been quick to capitalise on increasing investor enthusiasm for such products. A string of such funds have been launched recently and plenty more are expected to follow. Most will be multi-manager funds. These are products whose managers will buy funds run by other managers, hopefully giving you access to the expertise of the world's best investment talent.

For example, the HSBC World Selection Range – which has three portfolios covering cautious, balanced and dynamic approaches – has raised more than £1bn since it was launched a year ago. "The managers we use are handpicked and blended with the aim of delivering steady, long-term absolute returns, with low levels of volatility," says David Wells.

Opting for one of these means you will pay slightly more in charges – there will be fees for the fund as well as the underlying investment – in return for someone making the asset allocation and portfolio construction decisions. Fund groups will use investment professionals to make such calls, says Keith Swabey, managing director of the global multi-asset group at JPMorgan Asset Management. We use a combination of our in-house economic models and expertise to decide our asset allocation," he says. "This will then help us decide where we want to be overweight and where value can be found in each asset class." The amounts held in different asset classes will vary according to a fund's aims and objectives, as well as the manager's views. The M&G Cautious Multi Asset fund, for example, has 56.4 per cent of its assets in equities; 29.9 per cent in fixed interest; 7.1 per cent in property; 3.7 per cent in commodities; and 2.9 per cent in cash. Within these broad asset allocation calls, it has 52.6 per cent exposure to the UK and 15.1 per cent to Europe, with less in regions including the US, emerging markets and Asia.

So how should you pick the ideal multi-asset fund? Once an appropriate risk profile has been decided it all comes down to analysing funds, their returns, volatility and track record.

So which is best?

It all depends on your knowledge and the time you can devote to your portfolio, says Darius McDermott, managing director of Chelsea Financial Services. "Multi-asset funds are not for everybody and lots of people will want to do it themselves, but for those with less inclination – or time – I'd recommend the fund route," he says. "In fact it is the only environment in which we'd recommend paying extra to use a multi-manager."

Recommended funds

Geoff Penrice Honister Partners

* Jupiter Merlin Portfolio range of funds

* Cazenove Multi Manager Diversity

* Henderson Multi Manager Income and Growth.

Andy Gadd Lighthouse Group

* F&C Lifestyle range

* LV-managed portfolios

Darius McDermott Chelsea Financial Services

* HSBC Open Global Return

* CF Miton Special Situations

Do it yourself or buy multi-asset fund?

Do It Yourself

* Greater control over asset mix

* Potentially cheaper

* You have power to make changes

Buy a multi-asset fund

* Risk of choosing wrong assets

* A lot of time and effort required

* An experienced investment professional makes the decisions

Multi-asset investor: 'Don't put all your eggs in one basket'

Michael Stone has fully embraced the multi-asset investment philosophy after deciding it was virtually impossible to time the market correctly.

The businessman, 54, had invested in individual company shares before deciding he would be better to put his money in a number of OEICs and investment trusts.

He now has 14 funds, including the JPM Natural Resources fund and JPM Sterling Corporate Bond fund, into which he puts money every month as part of a retirement strategy.

"I didn't have the experience to judge the market and move as necessary," he explains. "Diversification is important to make sure you don't put all your eggs in one basket."

Mr Stone, from Atherstone, in Warwickshire, has a wide variety of funds giving him exposure to areas include large and small companies in Europe, North America, Japan, technology and commercial property.

"If one fund becomes successful I tend to take some money out of it," he explains. "I then use this for other investments, or to top up a fund I feel will perform well in the future."

He does have a word of warning for those that are tempted to follow a similar path. He said: "You need to understand what you have invested in before you add to your portfolio."