I wrote last time of the emerging trend of “objective based” or “real return” funds. If these funds are to have some longevity (which we think they do) and not just be a “flash in the pan”, then how should they be used in a portfolio context?
While much of the market has been strongly attracted to this ‘new’ concept of objective based investing (as if we didn’t have that before!), the only realistic way to gain access to this approach is via fund managers and the real return products they offer. That is, advisers cannot construct and / or manage clients’ portfolios in this way themselves.
The significant adjustments to the portfolio that may be required to meet fund objectives requires access to highly developed market valuation tools and comparisons, forward looking volatility and correlation forecasts and the ability to adjust portfolios quickly. Even those advice businesses operating a managed discretionary account (MDA), which allows them to adjust portfolios on the clients’ behalf do not have access to the tools and resources to enable them to manage these portfolios effectively.
As a result, advisers adopting this approach will need to utilise managed funds as the vehicle to execute this strategy. By default, they must philosophically accept that active management adds value. That is, fund managers, through the active adjustment of the respective fund’s asset allocation and security selection, will deliver upon their fund’s real return objective. This philosophy is the polar opposite to the approach many advisers adopted immediately post the Global Financial Crisis (GFC). Many lost faith in the ability of active managers to add value and we saw a huge move of investor’s money from actively managed funds into index funds.
So once advisers have become comfortable with the active management approach, the question then becomes how to use these funds in client portfolios.
With the exception of MLC, who have launched their real return funds using a multi manager approach, the majority of real return funds have been issued by managers managing all asset classes in-house. However, advisers are unlikely to use a single manager and fund provider for the management of 100% of their clients’ portfolios (perhaps with the exception of clients with small amounts to invest). As a result, they will either blend the fund with other real return funds in an attempt to achieve the client’s return objective or use the fund in another way.
The other ways advisers might use real returns funds are as:
- An asset allocation overlay product; or
- As an allocation within their alternatives allocation.
Given the flexible asset allocation ranges of most real return funds, advisers may use them as an asset allocation overlay product that provides an otherwise static portfolio with some ‘active’ asset allocation characteristics.
Second, while these funds may potentially blend well with other common alternative strategies such as CTA funds and global macro funds, their underlying asset allocation (i.e. high exposure to both equities and or bonds as certain times) will mean that they will correlate highly with the other major asset classes from time to time, thereby not providing the diversification alternative strategies are designed to provide.
So while the investment applications of the new real return funds are numerous, advisers will need to carefully consider how they will use them in client portfolios for best effect.
