Role of Multi-Asset Funds in Portfolio Construction

Multi-asset funds have gained recognition in investment for their distinctive role in portfolio construction. These funds are essentially investment vehicles that maintain a diversified portfolio by allocating capital across a wide array of asset classes such as stocks, bonds, commodities, and real estate.

The premise of multi-asset funds is rooted in the principle of diversification – a strategy that aims to maximise returns by investing in different areas that react differently to the same event. The value of portfolio diversification is highly significant, and multi-asset funds offer a practical solution.

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Core Concepts in Portfolio Construction

Modern Portfolio Theory (MPT)

The Modern Portfolio Theory (MPT) provides a theoretical backdrop for understanding portfolio construction. Developed by Harry Markowitz in the 1950s, MPT is a financial model that assists investors in creating a diversified portfolio of assets that maximises expected return for a given level of risk. The theory introduces the concept of the efficient frontier, a graphical representation of optimal portfolios that offer the highest possible expected return for a specific level of risk. MPT underscores the importance of the risk-return trade-off, and it is in this context that multi-asset funds come into play.

Asset Allocation

A crucial component of portfolio construction is asset allocation. This refers to dividing an investment portfolio among different asset classes based on an individual’s financial goals, risk tolerance, and investment horizon. An effective asset allocation strategy includes both strategic and tactical asset allocation. Strategic allocation is a long-term strategy that establishes and adheres to a base policy mix of assets, while tactical allocation enables investors to deviate from the strategic mix for short-term gains.

The Role of Multi-Asset Funds

Core Holdings

One key role that multi-asset funds can play in a portfolio is as core holdings. The fundamental advantage of these funds is their inherent diversification across asset classes. This diversification can significantly reduce risk by spreading investments across various asset classes that are not perfectly correlated. Moreover, the diversified nature of these funds can potentially enhance returns by exposing investors to multiple sectors and investment styles.

Complementary Asset Allocation

In addition to serving as core holdings, multi-asset funds can complement other asset classes in a portfolio. For instance, they can serve as a buffer to equities in a portfolio, providing stability when stock markets are volatile. The result is a well-rounded portfolio offering wider diversification, which can improve risk-adjusted returns and contribute to a more resilient investment strategy.

Portfolio Construction Strategies Using Multi-Asset Funds

Comprehensive Building Block Strategy

The comprehensive building block strategy is widely used for incorporating multi-asset funds into portfolio construction. This method involves using multi-asset funds as the central component of the fundamental ‘building block’ of an overall investment portfolio.

 Once the core is established, it is then supplemented with a variety of other asset classes. The purpose of this is to achieve specific investment objectives and to align the portfolio with the investor’s predetermined level of risk tolerance. By doing this, the portfolio can be tailored to meet the unique needs and goals of the investor.

Risk Parity Strategy: A Balanced Approach

In contrast to the building block strategy, the risk parity approach is another innovative strategy. This approach doesn’t focus on the allocation of capital, as traditional methods do. Instead, it emphasises the allocation of risk across a diverse range of asset classes. The primary objective of this approach is to establish equilibrium within the portfolio by ensuring that risk is equally distributed among all the included asset classes.

Multi-asset funds play a crucial role within this framework. They inherently balance risk across multiple asset classes, making them an effective tool for diversifying and managing portfolio risk. This approach can provide a robust risk management framework for investors, helping them to achieve a well-rounded, risk-adjusted return on their investments.

Considerations for Investors and Financial Advisors

Comprehensive Suitability Assessment

Determining how appropriate multi-asset funds are for inclusion in a portfolio is not a task to be taken lightly. It requires a comprehensive, detailed assessment that considers a variety of critical factors. These factors typically include the investor’s financial goals, their personal tolerance for risk, and the timeline they have for their investments. It’s also important to have a clear understanding of the investor’s need for liquidity, their requirements for income, and their goals for long-term capital appreciation. All these elements can significantly influence the suitability and, therefore, the selection of multi-asset funds for their portfolio.

Rigorous Due Diligence Process

The selection of multi-asset funds for a portfolio mandates rigorous due diligence. This involves conducting a thorough, in-depth evaluation of a wide range of factors. These factors should encompass the fund’s unique characteristics, its historical performance and projected future performance, the fees associated with it, and the fund manager’s qualifications and track record. Due diligence is crucial to ensure that the chosen multi-asset funds align with the investor’s overall strategic investment goals and risk tolerance.

In summary, multi-asset funds offer a versatile and effective tool in portfolio construction. By providing diversification across asset classes, they can serve as core holdings in a portfolio and complement other asset classes. Investors and financial advisors considering multi-asset funds should carefully evaluate their suitability and conduct thorough due diligence to ensure they align with their investment objectives and risk tolerance.



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