One of the current product, advice and portfolio construction trends is the emergence (or is it just relabelling?) of ‘real return’ funds and ‘objective-based investing’. The whole concept that objective or goals-based investing is new is, in itself, worrying. If we weren’t advising clients to invest with a clear objective previously, one questions what the industry was doing!
Nevertheless, objective-based investing has become the buzz word in the industry. This has coincided with the launch of a number of real return investment products by a number of fund managers. In the majority of cases, these products are diversified funds which by definition, invest in a range of asset classes and investment strategies. They differ from traditional diversified funds in three important ways:
- They have very specific investment return targets (for example CPI +4 per cent);
- They have much more flexible asset allocation ranges, providing the manager with the ability to adjust the asset allocation of the portfolio much more, in an effort to deliver upon their return objective; and
- They tend to have a stronger focus on protecting capital.
Of course, the ability to deliver a specific return with less volatility and greater capital protection than traditional diversified funds sounds terrific. This, along with dissatisfaction with the strategic asset allocation (SAA) approach and declarations by some fund managers that SAA is dead, has many in the market enthusiastically adopting this new approach.
Can real return funds deliver on their promises?
There is no doubt that investment management techniques and processes have evolved dramatically since the first diversified funds were introduced. However, there seems to be an assumption by many that the ability of these new funds to meet their investment objective is a fait accompli. However, the ability for managers to deliver upon their return objectives utilising these flexible asset allocation mandates relies on the accuracy of their investment market return, risk and correlation forecasts.
This is an area fund managers, and all investors for that matter, have struggled with historically. This is evidenced by the lack of ability of many managers to outperform their SAA benchmarks over time via the use of tactical asset allocation. Operating within even greater asset allocation ranges potentially increases the risk of getting it wrong.
So while these new generation real return diversified funds have strong appeal, the jury is still out on whether they will outperform the more traditional diversified funds over the longer term. More importantly, it remains to be seen as to whether they will deliver upon their real return objectives.
