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Important information
All information correct as at 29 September 2020 (unless stated). Issued by Architas Multi-Manager Limited, which is authorised and regulated by the Financial Conduct Authority.The value of investments and the income from them can fall as well as rise and is not guaranteed which means your client could get back less than they invest. Past performance is not a guide to future performance. Investments in newer markets, smaller companies or single sectors offer the possibility of higher returns but may also involve a higher degree of risk. The value of investments, and the income from them, can fall as well as rise purely on account of exchange rate fluctuations.Your client can invest in the funds mentioned in this document through a number of financial products. These funds may not be appropriate for investors who plan to withdraw their money within 5 years.The funds can invest entirely in units of collective investment schemes.From April 2020 Architas changed the primary share class of the blended fund range from A to S. The change of primary share class does not affect the underlying portfolio management, strategy or discipline of the fund. The primary share class is the highest charging unbundled class, free of any rebates or commissions and is freely available through third party distribution. Architas anticipate that this change would significantly improve outcomes for advisors and their clients as it should reduce confusion over the share class selected through the platforms. Due to this primary share class change, some information that is share class specific in this document will have changed from the original primary share class to the newly designated share class and as such, information in previous documents may not therefore be comparable. If you require information on the previous primary share class this can be found on the costs and charges update on our website architas.com.If you require further information on any of our funds, the Key Investor Information document (KIID) and the prospectus are both available free of charge on request from Architas Multi-Manager Limited.The KIID is designed to help investors to make an informed decision before investing. You can view or download all our funds’ KIIDs from our website at architas.com, by following the Key Investor Information documents link from the home page and in the Information Centre.This document does not constitute an offer to sell or buy any share in the funds. Information relating to investments is based on research and analysis undertaken or procured by Architas Multi-Manager Limited for its own purposes and may have been made available to other members of the AXA Group of Companies which, in turn, may have acted on it. Whilst every care is taken over these comments, no responsibility is accepted for errors and omissions that may be contained therein. It is therefore not to be taken as a recommendation to enter into any investment transactions.AXA is a worldwide leader in financial protection and wealth management. Architas operates three legal entities in the UK; Architas Multi-Manager Limited (AMML), Architas Advisory Services Limited (AASL) and Architas Limited. Both AMML and AASL are owned by Architas Limited, which is 100% owned by AXA SA (a company registered in France). AMML is an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. AMML is a company limited by shares and authorised and regulated by the Financial Conduct Authority (Firm Reference Number 477328). It is registered in England: No. 06458717. Registered Office: 5 Old Broad Street, London, EC2N 1AD.The AXA Group includes other fund management companies which we refer to as in-house managers, such as AXA Investment Managers and Architas Multi-Manager Europe Limited. We, Architas, may choose to include funds managed by in-house managers, which we refer to as in-house funds, in our multi-manager funds. In the UK, we follow an in-depth research process that ensures that the funds selected for our multi-manager funds are included on the potential benefits they could bring to our Architas funds. We are not influenced by the AXA Group to include in-house funds over funds from other fund managers; funds are selected on their consistency to meet their objectives. We regularly review our selection of funds, including those from in-house managers, to ensure they continue to be appropriate and in your clients’ best interests. More information about our use of funds from in-house managers is available at architas.com/inhousemanagers
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Uncharted waters
How to navigate market turmoil through a blended multi-asset solution
All information correct as at 29 September 2020 (unless stated). Issued by Architas Multi-Manager Limited, which is authorised and regulated by the Financial Conduct Authority. The value of investments and the income from them can fall as well as rise and is not guaranteed which means your client could get back less than they invest. Past performance is not a guide to future performance. Investments in newer markets, smaller companies or single sectors offer the possibility of higher returns but may also involve a higher degree of risk. The value of investments, and the income from them, can fall as well as rise purely on account of exchange rate fluctuations. Your client can invest in the funds mentioned in this document through a number of financial products. These funds may not be appropriate for investors who plan to withdraw their money within 5 years. The funds can invest entirely in units of collective investment schemes. From April 2020 Architas changed the primary share class of the blended fund range from A to S. The change of primary share class does not affect the underlying portfolio management, strategy or discipline of the fund. The primary share class is the highest charging unbundled class, free of any rebates or commissions and is freely available through third party distribution. Architas anticipate that this change would significantly improve outcomes for advisors and their clients as it should reduce confusion over the share class selected through the platforms. Due to this primary share class change, some information that is share class specific in this document will have changed from the original primary share class to the newly designated share class and as such, information in previous documents may not therefore be comparable. If you require information on the previous primary share class this can be found on the costs and charges update on our website architas.com. If you require further information on any of our funds, the Key Investor Information document (KIID) and the prospectus are both available free of charge on request from Architas Multi-Manager Limited. The KIID is designed to help investors to make an informed decision before investing. You can view or download all our funds’ KIIDs from our website at architas.com, by following the Key Investor Information documents link from the home page and in the Information Centre. This document does not constitute an offer to sell or buy any share in the funds. Information relating to investments is based on research and analysis undertaken or procured by Architas Multi-Manager Limited for its own purposes and may have been made available to other members of the AXA Group of Companies which, in turn, may have acted on it. Whilst every care is taken over these comments, no responsibility is accepted for errors and omissions that may be contained therein. It is therefore not to be taken as a recommendation to enter into any investment transactions. AXA is a worldwide leader in financial protection and wealth management. Architas operates three legal entities in the UK; Architas Multi-Manager Limited (AMML), Architas Advisory Services Limited (AASL) and Architas Limited. Both AMML and AASL are owned by Architas Limited, which is 100% owned by AXA SA (a company registered in France). AMML is an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. AMML is a company limited by shares and authorised and regulated by the Financial Conduct Authority (Firm Reference Number 477328). It is registered in England: No. 06458717. Registered Office: 5 Old Broad Street, London, EC2N 1AD. The AXA Group includes other fund management companies which we refer to as in-house managers, such as AXA Investment Managers and Architas Multi-Manager Europe Limited. We, Architas, may choose to include funds managed by in-house managers, which we refer to as in-house funds, in our multi-manager funds. In the UK, we follow an in-depth research process that ensures that the funds selected for our multi-manager funds are included on the potential benefits they could bring to our Architas funds. We are not influenced by the AXA Group to include in-house funds over funds from other fund managers; funds are selected on their consistency to meet their objectives. We regularly review our selection of funds, including those from in-house managers, to ensure they continue to be appropriate and in your clients’ best interests. More information about our use of funds from in-house managers is available at architas.com/inhousemanagers
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Coronavirus aside, there are plenty of issues to concern investors; in a normal year these would be the main talking points. Today, they seem to have been relegated to the back pages: from Brexit and upcoming global elections, to political and military posturing in south east Asia, US/China trade relations… the list goes on. In the meantime, though, after suffering a massive drawdown, equity markets have enjoyed a swift recovery, and several indices are now at record highs. Architas’ portfolios have navigated the turmoil relatively well: our long-term approach, combined with a strong investment process that allows for nimble tactical asset allocation and fund selection, has stood us in good stead in the period of heightened volatility. The mix of active and passive funds in the Blended range has been dynamically adjusted to take advantage of the fast-changing environment; this flexibility is a hallmark of the range and we detail our process in this guide.
We are excited about the opportunity to grow our business
A new home for our UK funds Architas recently announced the sale of its UK funds business to Liontrust with the deal due to complete at the end of October. Subject to approval by Liontrust’s shareholders, the deal will complete on 31 October 2020. The Architas portfolios will be renamed under the Liontrust banner - but apart from that, very little will change. The UK portfolio managers will transfer across to Liontrust, and we are committed to ensuring a seamless transition. The philosophy of the Blended fund range (indeed, of our full proposition) will not change, nor will the underlying investment process. We are excited about the opportunity to grow our business through continued delivery of strong risk-adjusted performance and building relationships with clients. Sheldon MacDonald, deputy-CIO, Architas
hat a momentous year for financial markets it has been. The pandemic has of course taken centre stage, bringing the global economy to its knees in the early part of the year, although as
global lockdowns have eased, some signs of recovery have begun to emerge.
This is for professional clients only and should not be distributed to or relied upon by retail clients.
Sheldon MacDonald, deputy-CIO, Architas
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SPOTLIGHT
Diversification was once described as ‘the only free lunch in finance’; a term supposedly thought up by Harry Markowitz, the orchestrator of Modern Portfolio Theory. For its time, Modern Portfolio Theory was revolutionary. It was used to construct a diversified portfolio of assets that maximised returns within a given level of risk. Effectively it theorised a portfolio that is diversified across different assets allows investors to manage or reduce downside risk, whilst sacrificing little in expected returns over a long-term period – hence the term ‘free lunch’.
The changing face of diversified portfolios
Architas’ Sheldon MacDonald and Mayank Markanday explore three ways in which diversification strategies have evolved in recent decades, as traditional allocations are increasingly shunned in favour of more flexible and risk-focused strategies
The story of diversification
The theory has evolved over the years. First and most notably into the 60/40 equities/bond split, and later into fully diversified multi-asset portfolios that are not just global in their construction but now include asset classes such as corporate and high-yield bonds, property, private equity, leveraged loans, commodities and hedge funds. The introduction of risk-profiled solutions in the 2000s was the next development in diversification strategies, turning the focus away from returns towards risk. It allowed investors to select portfolios that would constantly reflect their attitudes to risk, regardless of changing market dynamics.
“The move away from fixed allocation and 60/40 modelling is an evolution that is quite close to our heart, as we were there almost at the beginning of that phase, as pioneers,” notes Sheldon MacDonald, deputy CIO at Architas, who adds the firm was one of the first to offer risk-profiled multi-manager funds across the passive, active and blended styles of investing. “Having fixed allocations in a portfolio means you can’t really adapt or adjust portfolios as markets evolve, so the volatility of that portfolio will increase and decrease over time, depending on what markets are doing. That is what gave rise to the idea of risk profiling: the idea that clients, whilst obviously concerned about the end result, are also concerned about the journey along the way. If a provider can offer a solution that aims to mitigate some of those more volatile periods, then it allows investors to be much more comfortable in the knowledge that they won’t suffer too many bumps on the road to their final outcome.”
According to MacDonald the events of the past decade mean risk-profiled solutions are growing in popularity, as investors become much more aware of their capacity for loss. And as investor willingness to accept risk decreases in the face of ongoing market uncertainty, the use of risk-profiled solutions will increase significantly.
Diversification was once described as ‘the only free lunch in finance’
Over the past decade, the introduction of quantitative easing has continued to distort financial markets and asset prices in particular. Central banks’ bid to stimulate the global economy via asset purchases has created an artificial environment of low volatility, and “conditioned investors to expect stable returns no matter what”, says senior investment manager Mayank Markanday. In turn, diversification was almost too easy over the past decade as values nearly always rose, he adds. “Investors have been spoilt over the past decade in terms of the scale of return they were able to get versus the amount of risk they took on,” explains Markanday. “But that isn’t the norm. Decades like that come along from time to time but markets have arguably been batting way above the average for years. Investors have become a bit too used to strong returns with very low volatility.”
Rise of the alternatives
MacDonald agrees: “The massive injections of liquidity around the world since 2008 led to the overall appreciation of financial assets across the board. Whilst the standard logic says when equities move up, bonds will move down, what we have had instead over the past decade or so is the longest bull market in history for stocks. At the same time, bonds have been in a 30-to-40-year bull market as well. But by the same token, it means there is a risk that equities and bonds could both fall at the same time. So what have we had to do? Look for diversification elsewhere.” At Architas alternative assets have filled this gap, with the firm predominantly focusing on real asset, infrastructure and absolute return strategies in their multi-asset portfolios. They are not alone. The alternatives sector is set to reach an estimated $14trn by 2023 according to Prequin – a considerable rise as it was valued at $8.8trn three years ago.
MacDonald says whilst these are not asset classes that are completely negatively correlated to equities, they can – if used in the correct way – “be a reliable hedge in a portfolio, particularly in volatile markets.” Going forward, the importance of alternative assets in a diversified portfolio is likely to be even more important.
Early on in 2020, equity markets fell by more than 30%, as fears of coronavirus and country-wide lockdowns hurt global economies. Whilst fixed income did its job during the period in terms of acting as a diversifier and gained whilst equity markets plummeted, yields are now exceptionally low and valuations extremely high; it is clear that the ability of fixed income to provide the same degree of diversification and hedging in a portfolio is going to be limited moving forward. Some investors have questioned whether the balance between risk and return is broken, as bond yields reach new all-time lows. “The ability of bonds, particularly government bonds, to protect portfolios is limited as the starting point for yields is too low. Therefore the magnitude of return that you can expect from the asset class is meaningfully lower versus previously, and therefore its potency as a diversifier to equity risk. It means investors need to also look elsewhere for risk-off assets,” says Markanday.
Alternative assets under management in 2023
Source: Preqin
With markets having sold-off in March 2020, and having rebounded back before the summer had ended, the need for portfolio rebalancing has become essential in order to capture investment upside. Those portfolios without a disciplined rebalancing policy (such as unconstrained/macro multi-strategies for example) are likely to have missed out on significant returns and possibly timed entry/exit points incorrectly thus impacting long-term returns. Markanday notes this is something the Architas team try to avoid. All Architas funds are rigorously monitored and rebalanced to ensure they remain in line with their risk parameters and perform in line with their investment objectives. But Markanday notes this process is becoming ever more important as global market events challenge assets and volatility increases. The Blended fund range uses a strategic asset allocation framework provided by EValue to guide the fund manager. However, Architas also has a number of tactical abilities to allow managers to deviate from the quant model.
The need to rebalance
This is a particularly useful tool to ensure managers can over/underweight positions relative to the suggested allocations in times of heightened uncertainty, such as early on in 2020. By doing this, it allows the firm to incrementally add value where possible, in particular through avoiding risk. Such changes have to be done within their set risk framework, and the portfolios always respect the risk profiles that have been set. “The risk of not rebalancing systematically is that you implicitly and passively embed an expectation about the future market direction causing you to deviate from your model neutral,” says Markanday. “For example, we were quite obviously in the midst of the storm early on in 2020, and it is proven that in such scenarios, investors tend to sell low and buy high as they seek to protect their investments. But our disciplined and systematic process of rebalancing that is built into our investment process, allowed us to offset these behavioural biases. It allowed us to maintain our overall principle of staying diversified and targeting risk levels whilst remaining invested.”
$8.8trn
$14trn
+59%
2017
2023
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“The move away from fixed allocation and 60/40 modelling is an evolution that is quite close to our heart, as we were there almost at the beginning of that phase, as pioneers,” notes Sheldon MacDonald, deputy CIO at Architas, who adds the firm was one of the first to offer risk-profiled multi-manager funds across the passive, active and blended styles of investing.
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“Having fixed allocations in a portfolio means you can’t really adapt or adjust portfolios as markets evolve, so the volatility of that portfolio will increase and decrease over time, depending on what markets are doing. That is what gave rise to the idea of risk profiling: the idea that clients, whilst obviously concerned about the end result, are also concerned about the journey along the way. If a provider can offer a solution that aims to mitigate some of those more volatile periods, then it allows investors to be much more comfortable in the knowledge that they won’t suffer too many bumps on the road to their final outcome.”
2/2
This is a particularly useful tool to ensure managers can over/underweight positions relative to the suggested allocations in times of heightened uncertainty, such as early on in 2020. By doing this, it allows the firm to incrementally add value where possible, in particular through avoiding risk. Such changes have to be done within their set risk framework, and the portfolios always respect the risk profiles that have been set.
“The risk of not rebalancing systematically is that you implicitly and passively embed an expectation about the future market direction causing you to deviate from your model neutral,” says Markanday. “For example, we were quite obviously in the midst of the storm early on in 2020, and it is proven that in such scenarios, investors tend to sell low and buy high as they seek to protect their investments. But our disciplined and systematic process of rebalancing that is built into our investment process, allowed us to offset these behavioural biases. It allowed us to maintain our overall principle of staying diversified and targeting risk levels whilst remaining invested.”
The theory has evolved over the years. First and most notably into the 60/40 equities/bond split, and later into fully diversified multi-asset portfolios that are not just global in their construction but now include asset classes such as corporate and high-yield bonds, property, private equity, leveraged loans, commodities and hedge funds. The introduction of risk-profiled solutions in the 2000s was the next development in diversification strategies, turning the focus
away from returns towards risk. It allowed investors to select portfolios that would constantly reflect their attitudes to risk, regardless of changing market dynamics. “The move away from fixed allocation and 60/40 modelling is an evolution that is quite close to our heart, as we were there almost at the beginning of that phase, as pioneers,” notes Sheldon MacDonald, deputy CIO at Architas, who adds the firm was one of the first to offer risk-profiled multi-manager funds across the passive, active and blended styles of investing.
Rebalancing portfolios is becoming more important as global markets challenge assets
Looking beyond peak passive
Market events have revived the argument of whether passive instruments could see their first real downturn in the coming year. But the reality may not be so clear
he huge growth of passive investing has been one of the defining features of the bull market since 2009. However, its rise goes back to the 1970s with investors being offered the chance to invest in a lower-cost and more
transparent way by the likes of Vanguard’s Jack Bogle, a passive fund pioneer. Though he was often ridiculed by his peers, the appeal of this type of investing was clear: it is a low-cost investment solution that provides diversification and eliminates individual stock risk. Importantly, it is an alternative way to build wealth versus active funds.
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Sheldon MacDonald, deputy chief investment officer at Architas, notes the passive investing rise to popularity is today an almost “self-fulfilling” prophecy: “As more and more money flows into passives, managers have to invest it accordingly in line with index weights. That pushes the index heavyweights higher, more money is then invested into those companies and they continue to outperform. Yet active managers, wary of concentration risks, may have been underweight such stocks, and as a result underperform. So you get stuck in a cycle that keeps pushing passives flows and performance higher, which active strategies struggle to match.”
There is no doubt, however, that most investors will aim to avoid tracking market indices downwards. And there are several reasons why active funds are able to perform better than passives in bear markets. Whilst passive funds will hold stocks in proportion to the make-up of the entire index, active funds are able to build in defensive barriers such as cash and bonds in small or large amounts. This will arguably provide the portfolios with an advantage over passives if markets turn.
Best of two worlds
Architas’ Blended Fund range aims to marry the strengths of both styles by producing returns from a ‘blend’ of them. But rather than splitting allocation equally between active and passive exposure, the fund managers tactically select where and when to use passive allocation through a combination of quantitative and qualitative analysis. Unusually, the funds have no prescribed active/passive holding ratio, rather excess returns are analysed across asset classes and then by investment style, before being combined as appropriate for the fund’s specific return and volatility objectives.
“The research told us what we intuitively already knew, that trackers do typically spend more time in the upper half of these performance tables rather than the bottom. It also showed tracker funds are particularly suited to ‘efficient’ asset classes such as US and UK equities and government bonds; these are two areas where it is difficult for active managers to outperform,” explains MacDonald. “But we wanted to be careful and not oversimplify the results based on that data.
“We like to think that even if there are fewer managers likely to outperform in certain sectors, we’d still be able to find the outperformers - after all, we still have a US equity analyst, even if it’s hard for managers there to outperform. But even if we can find them, maybe it’s still not worth using them in the portfolio, depending on how much alpha they can deliver. So we also looked at the scale of the potential outperformance.” To do this, Architas used something it calls the ‘inter-decile range’: this is the average difference between the top decile and bottom decile funds of each sector. This was a proxy for the ‘size of the prize’ effectively - if an outperformer was found, how much alpha was that fund likely to deliver?
MacDonald notes: “We found that in general, equity funds tend to offer greater potential alpha than fixed income funds, apart from EM Debt funds - again, a very inefficient area. And within equities, the efficient markets (US, UK, Europe) tend to offer less potential than the less efficient markets (Asia, EM, Japan).” Whilst the analysis proved what was expected from passive/active fund performance, it also served as a cost/benefit analysis, helping managers to choose where it spends its investment budget. Though they can find active outperformers in most sectors, they won’t buy active funds in all sectors, because they need to spend their budget in those areas where outperformance can be maximised.
Investing naysayers
So far, those predicting the passive investing style’s doom have been proved wrong. Even in the face of heightened market volatility, passive providers BlackRock and Vanguard saw net inflows of more than $140bn in the first six months of 2020. Some of the largest active fund houses reported multi-billion dollar net redemptions over the same period. More investors also turned to fixed income passive vehicles as investors sought more stable returns during the period, rather than having to add to risk for higher returns as active managers may do.
MacDonald believes there is a good argument for both styles of investing at the moment, which is beneficial for the Blended range’s flexible approach to both active and passives: “In a volatile environment, we see a lot of ‘babies thrown out with the bathwater’ and stocks sell off quite indiscriminately. During a recovery, and what we are seeing currently, is that a lot of stocks are being bought indiscriminately, prices being pushed up to levels not justified by their fundamentals. So at different points there will be a fertile harvest ground for both active and passive products.
“Cost is also a big deal in fund management, as it should be whether you are investing in passives or active managers, and this should also drive decisions in difficult markets,” he adds. For example, passives exude natural advantages such as lower fees that help compound growth, and mitigate losses in a low-return era. However, there is much to be said about underlying value-add active funds can offer in times of market turmoil too: “Many of the active exposures within the Blended range have outperformed, particularly on the downside and so if there is the opportunity for higher returns through active exposure then it is, we believe, worth the basis points increase in fees.”
Passive management now accounts for nearly half of all assets for U.S. stock-based funds
That’s up from just around 25 percent a decade ago
45%
25%
Source: BoAML; 2019
If there is the opportunity for higher returns through active exposure then it may be worth the basis points increase in fees
Source: PwC analysis based on data from ICI. Estimates from 2025 based on PwC analysis.
US mutual fund industry assets: Actual and projected active/passive split
$10.2 T
$18.3 T
$26.8 T
79%
64%
50%
21%
36%
AUM ($%)
Active
Passive
Growth
103%
208%
2011
2018
2025
To determine whether active managers do well in a sector, Architas looked at the relative performance of a standard tracker fund in that sector (using the tracker fund as a proxy for the benchmark). If the tracker fund was near the top of the rankings, then active managers were the underperformers, and vice versa.
The team care passionately about investing in clean energy
hether investors are aiming for a cautious approach or a riskier investment profile with the potential for higher returns, Architas’ Blended Fund range is designed to match a range of investor risk
appetites. And like many asset managers, Architas predominantly uses two approaches to define asset allocation within the five risk bands used in the Blended Range – strategic and tactical.
Under the bonnet: Managing the risk model
Portfolio management tools and risk models are central to asset allocation. But it is no longer enough for asset management groups to simply be ‘model takers’. An active approach to manage constraints within a model is necessary to ensure success
“As investment managers we are tasked with analysing the underlying funds within portfolios to ensure we have included the optimum blend of investments to achieve the specific risk and reward balance for each risk profile,” explains Architas’ Deputy CIO, Sheldon MacDonald. “There is a certain amount of investor skill and experience, alongside our strategic risk modelling service that helps us achieve this. But in addition, our approach to ‘actively’ managing our risk model allows us to install better constraints and ensure that the portfolios don’t just meet the quantitative risk/reward goals we set, but also, make sense, from a real-world perspective.”
The strategic asset allocation for all of the funds within the range is set by independent risk modelling company EValue, and this is the starting point for all fund analysis. The managers use the risk model suggestions as a starting point for the portfolio construction process. They then introduce a tactical overlay to avoid short-term risks or to take advantage of short-term market opportunities. In constructing the portfolios, they identify active funds that offer potential for outperformance and alpha generation. This is combined with passive funds to provide lower cost access to more developed, efficient markets.
Short-term movements
EValue’s quantitative approach to asset allocation takes into account the long-term performance of different asset classes and the likely future performance given current valuations, along with long-term measures of volatility and correlations with other asset classes. Yet as with most systems of its kinds, EValue focuses on the long term; it is unable to analyse short-term market movements and fluctuations. So whilst it would have seen that in Q1 2020 markets fell by a record percentage before rebounding, it will not be able to factor in the cost of the coronavirus and lockdown and its impact on markets. Similarly, it is not able to consider ongoing Brexit woes, geo-political trade wars or the outcome of the US election in 2020.
“EValue offers a set of asset allocations that does not drop down into anything to do with the underlying funds. That part is decided by us as portfolio managers. But what EValue does provide us with is an asset allocation model that allows you to see, in each risk band, the highest expected level of returns for the lowest level of risk. It helps us effectively define, or get as close to defining as we can, an efficient frontier for a particular level of risk. The idea is that if we then invest exactly in EValue’s asset class weights, we would be in the middle of the risk bands.”
So far, so normal. Yet, the data driving EValue’s model is, by definition, very long term – 15 years’ worth of history is used to give a 15 year outlook – so short-term moves take some time to impact the allocations determined by the model.
Whilst risk models can analyse market falls, they are unable to consider ongoing Brexit woes, or geo-political trade wars
“This long-term outlook of the risk model means that whilst it will always register market movements – even short, sharp corrections such as the one we saw earlier this year, relative to 15 years’ worth of data, that event carries much less weight than one would assume.”
Active risk modelling
But it is Architas’s ‘active’ approach to the risk model’s constraints that are helping it to take advantage of better long-term opportunities, says MacDonald. “The EValue model we use is unique to us, and it has been designed specifically so that we can work with them to define the asset classes that are offered to the model, determine the time horizon(s) we want to look at, and also the number of risk levels that we want to use. In addition to this, we as portfolio managers can introduce constraints into the model where we think it is necessary.”
Source: Architas February 2020.
Investment process steps
strategic asset allocation (SAA)
EValue model input
Tactical asset allocation (TAA)
- Based on short-term market views
portoflio management
Allocation within asset classes
manager selection
Looking for consistent alpha generation
- Aims to add alpha
Whilst many providers look to use risk levels between 1 and 10, it can be difficult to stay within such granular risk bands and provide expressions to the views that managers want to put into the portfolios. Architas instead works on risk levels from 1-7, with slightly wider bands in order to allow managers the freedom to add value using tactical tools.
“It is in the nature of quantitative models to seek out what we call ‘corner solutions’. In extremely simple terms this means that despite having a wide range of asset classes to choose from, the model finds the best risk and reward profiles by simply choosing two or three asset classes to invest in. In some cases, the model will actually ignore some asset classes completely, whilst giving us a concentration in others.
Minimum asset exposure
In noticing that the model could avoid asset classes in such scenarios, MacDonald and the team decided to ensure the model had a minimum level of exposure to every asset class. “We questioned ourselves on this for a little while; because the most optimal one may be the one the model provides you with, but there are hundreds and hundreds of other portfolios with different weightings that deliver you the same or an extremely similar result.”
Architas conducted a number of iterations with this analogy in mind and found that by introducing minimum asset class levels, the impact on the risk/return profile of the portfolio was almost non-existent. However, MacDonald notes, it is a delicate balance to ensure the team does not constrain the model too much.
“We believe in the model, in the risk profiling framework. We have built entire propositions around it, and so we need to give the model freedom to move. But on the other hand we want to make sure we are getting the absolute best diversification in our portfolios, and realistic diversification for our clients.”
This is an important point, adds Sheldon MacDonald, as most risk models are focused on the dispersion of returns and low volatility over a period of time. In many cases, models are simply not equipped to understand the risks associated with many underlying asset classes. Take property assets, for instance, where valuations move much slower and over a longer period of time. What the model understands from historical returns is that the asset class offers a very steady and low volatility set of returns. In an unconstrained framework, the risk model may choose to place a large chunk of a portfolio in property. “That is just not realistic,” says MacDonald. “Investing in property introduces a number of risks that a quantitative model can’t handle; liquidity risk is an obvious example.” By constraining the model, the team ensure that the eventual asset allocation for each risk level is very close to being optimal from an expected risk/return perspective, whilst also working from a practical, real-world perspective.
There is an infinite number of portfolios that can be created with risk-modelling technologies
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he alternatives sector has faced considerable headwinds as a result of global uncertainties over the past few years, from Brexit to geopolitical trade wars and coronavirus. Over the past 18 months, property has been
one of the most hard hit asset groups in the sector. Asset managers including Aberdeen Standard Investments, BMO, Janus Henderson and Aviva Investors have been forced to suspend trading on open-ended property funds as market swings caused widespread investor panic and a run on liquidity. The high-profile suspension and resulting closure of the Woodford Equity Income Fund, partly as a result of his investments in illiquid, private equity based alternatives, refocused investors’ attention on the issue of liquidity once again in 2019.
However, with the quest for yield representing one of the biggest challenges for fund managers today as bond yields hit rock bottom, the role of alternatives is unlikely to wane, according to Architas’ Mayank Markanday. Here we look at some of the key considerations needed when investing in alternative assets and amidst high volatility markets.
Liquidity matters
High-profile redemptions in the alternatives sector, particularly property, are shining an unflattering spotlight on the sector. However, their role in a diversified portfolio can be a crucial hedge against market volatility
Correlations
The need to analyse the relationship between alternatives and traditional assets is much more important today if investors want to make sure their investments are not correlated and portfolio diversification will work when you need it the most.
Alternatives by their nature usually have a lower correlation, with other risk assets. This means by using the ‘right’ alternatives in a diversified portfolio, the overall volatility of a portfolio can be reduced. This is the case with alternatives such as gold, says Markanday.
However, the idea that all alternative assets are uncorrelated to stocks is not correct. Some alternatives are highly correlated to equities, such as REITs which trade on the London Stock Exchange and are therefore exposed to daily trading movements. “In terms of diversification, however, not all REITs are alike. Commercial REITs which invest in hotels, leisure, offices, or high street retail are a lot more sensitive to falling demand, and therefore it’s a sector you want to be underweight in the later stages of an economic cycle. Instead, we have a preference to allocate to more defensive property names, like Primary Health Properties which invests in healthcare properties or Civitas, a REIT that owns portfolios of social housing. These are examples of defensive REITs with government backed cashflow, so the income and cash-flows are much more stable and less influenced by a weakening economy. These alternatives can provide attractive income and have proven to be a good hedge in the portfolio this year.”
By using the ‘right’ alternatives in a diversified portfolio, overall volatility could be reduced
It is important to have the ‘right’ mix of alternative assets, to ensure they not only complement the portfolio as a whole but each other as well. For example, funds in the Architas MA Blended Fund range have a diversified mix of alternative exposures with a combination of renewable, social infrastructure, specialist property and more recently gold which was introduced to the portfolio earlier this year.
Type of alternative assets
“Gold has proven to be a reliable hedge this year and it is also liquid as an alternative, which is not available in every alternative investment that we own. It is however a widely traded asset so we do have to be mindful of the technical and momentum effects, that can drive short-term volatility.”
There is also a small exposure to commercial property in the Blended funds via investment trusts (< 1%) which, due to its cyclical bias, has been impacted by market events and has shown a much higher correlation vs. equities. However, the range’s exposure to infrastructure has balanced this performance with the funds investing in JLEN Environmental Assets Group and The Renewables Infrastructure Group, as well as through exposure to specialist property such as doctor surgeries on long government-backed leases. By balancing a number of alternative assets with passive investments and traditional bonds and stocks, the Blended Fund range is able to offer a truly diversified portfolio of assets.
The liquidity spectrum
Liquidity
Alternative assets by their nature vary, and if you are buying real assets or a fund associated with distressed debt or private equity, the assets in question may not be traded every day but priced monthly or quarterly. Prices are often based on net asset value. Therefore, alternatives in general, and specifically real assets, are more illiquid than publically traded stocks and fixed income. The key to capturing the so-called illiquidity premium they offer is a long-term outlook, however as various redemptions from recent years show, this is not always the case.
“Investing in property via an open-ended property fund, where assets are valued on a monthly or quarterly basis, can be effective in dampening down short-term volatility in a balanced portfolio. That delay in pricing can allow market shocks to dissipate. This may be valuable in a highly volatile period such as the one we saw earlier this year. Larger REITs which are more liquid and trade on the stock exchange experienced falls of between 30%-50% at the height of market turmoil. Yet open-ended property funds dropped only a few percent as they were still being priced at stale prices. Whilst this reduces the large mark to market negative impact of REITS in the short-term, it comes at a cost of much lower liquidity. In fact, most daily dealing open-ended property funds have gated as they also did during Brexit which highlights the weakness in the structure of these daily dealing property OEICS. Therefore for investors who require short-term liquidity these may not be the most appropriate vehicle”.
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The spectrum
“Investing in property via an open-ended property fund, where assets are valued on a monthly or quarterly basis, can be effective in dampening down short-term volatility in a balanced portfolio. That delay in pricing can allow market shocks to dissipate. This may be valuable in a highly volatile period such as the one we saw earlier this year. "Larger REITs which are more liquid and trade on the stock exchange experienced falls of between 30%-50% at the height of market turmoil. Yet open-ended property funds dropped only a few percent as they were still being priced at stale prices. Whilst this reduces the large mark to market negative impact of REITS in the short-term, it comes at a cost of much lower liquidity. "In fact, most daily dealing open-ended property funds have gated as they also did during Brexit which highlights the weakness in the structure of these daily dealing property OEICS. Therefore for investors who require short-term liquidity these may not be the most appropriate vehicle”.
However, the idea that all alternative assets are uncorrelated to stocks is not correct. Some alternatives are highly correlated to equities, such as REITs which trade on the London Stock Exchange and are therefore exposed to daily trading movements. “In terms of diversification, however, not all REITs are alike. Commercial REITs which invest in hotels, leisure, offices, or high street retail are a lot more sensitive to falling demand, and therefore it’s a sector you want to be underweight in the later stages of an economic cycle. "Instead, we have a preference to allocate to more defensive property names, like Primary Health Properties which invests in healthcare properties or Civitas, a REIT that owns portfolios of social housing. These are examples of defensive REITs with government backed cashflow, so the income and cash-flows are much more stable and less influenced by a weakening economy. These alternatives can provide attractive income and have proven to be a good hedge in the portfolio this year.”
Alternatives by their nature usually have a lower correlation with other risk assets
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he value sector’s outperformance has been fleeting over the past decade, with the predominantly out of favour category’s return profile having been thwarted by outperforming growth stocks, particularly in
the technology sector.
Recent market movements haven’t done much to change this trend. Following value’s prolonged underperformance, the market sell-off earlier this year saw the performance gap between growth and value widen significantly. Today the MSCI Value and MSCI Growth average P/E level is at an all-time low of 0.45. This compares to its average ratio of 0.7, which has been the norm for over a decade. It seems that the value premium that once existed has all but vanished from stockmarkets.
Is the value stage set for recovery?
With today’s value/growth valuation gap at record levels, is the value style of investing heading for historic outperformance relative to growth?
“The gap between growth and value P/E is probably the highest it has ever been for twenty years, and there are some reasons for that,” notes Mayank Markanday, senior investment manager at Architas. “Firstly, we are in an era of prolonged falling interest rates and inflation. Historically, these two factors pointing and heading in the same direction are not favourable for the value style of investing. Furthermore the availability of cheap credit has also been supportive for growth stocks, which typically need capital to reinvest into their business to support the early growth phase. Falling bond yields and a flattening of the yield curve, are also not favourable for financial stocks, a large component of the value index, which have remained under pressure pretty much since the last crisis.
“Secondly, some of the growth stocks we refer to today can actually be seen as ‘quality’ stocks that are simply growing at a high rate. They are not what we would deem traditional growth stocks. Take your FAANGs – Facebook, Apple, Amazon, Netflix and Alphabet (previously Google). Quality stocks are those where high prices are rooted in strong current and forecast earnings and sound fundamentals. Not only are these companies generating high net returns and income, they have strong balance sheets, low debt, and have been able to withstand the cyclical pressures of the market.
Value elevated
It is no secret that the end of a market bull run, and especially as an economy accelerates out of a recession, value stocks tend to outperform. This is because in the short-term, negative investor sentiment leads to very cheap valuations for some stocks, and the potential for higher rewards as they recover, over and above growth stocks.
According to Research Affiliates, with today’s extreme value/growth valuation gap the stage is set for potentially historic outperformance of value relative to growth over the coming decade. The group points out that whilst the source of value premium is controversial, (often viewed by investors as a compensation for bearing risk or simple mispricing), if there is any tendency for mean reversion (as history suggests) the expected future returns for value are, by almost any definition, elevated.
They are not alone in their predictions. Bank of America Merrill Lynch stated in a recent note that a wide dispersion in valuations between growth and value stocks usually precedes value cycles. For example, value outperformed its last market lows of 2003 and 2008 by 22 ppt and 69 ppt respectively over the subsequent 12 months. “When valuation dispersion has been this high or higher, value stocks have outperformed growth 95% of the time over the subsequent months,” the group noted.
Markanday believes the current hit to value investing is rational, given the fact value stocks are often cyclically focused and more prone to being distressed stocks too. The shock of the coronavirus crisis earlier this year and its multi-layered impact on the market is therefore unsurprising. It is also important to remember the widening spread between the two styles of investing is also reflective of the stretched valuations being seen amongst so-called growth stocks. Amazon, for example, is trading at more than 120x earnings.
“From a multi-asset perspective, we can take advantage of valuation discrepancies but also maintain a broad exposure to different styles like value and growth quality, minimum volatility, and so on. That is the benefit of a multi-asset multi-manager approach, where we have the whole toolkit available to us and we can over or under weigh different styles depending on valuations, fundamentals and points in the business cycle” explains Markanday.
“At the end of 2019, the equity allocation of the Architas Blended range was split close to 50/50 quality growth/value. However, since the beginning of the year we have tilted the portfolio more towards quality growth whilst still maintaining some exposure to value. Although the value style faces some cyclical headwinds, I do believe there is the potential possibility that if the cycle turns, the historically cheap valuations can lead to meaningful re-ratings.”
Sources: MSCI; Inc. US Labor Dept.
Tracking the value/growth journey
When valuation dispersion has been this, value stocks have outperformed growth 95% of the time over the subsequent months
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Growth stocks
1975-1988
Value stocks
1989-1999
2000-2006
2007-2020
620%
290%
115%
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54%
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15%
Architas MA Blended Intermediate Fund
The Blended Fund range is a multi-asset multi-manager range of five funds across different risk profiles. Below is a snapshot of the MA Blended Intermediate Fund
Fund aim
The Fund seeks to achieve capital growth and income with a median level of volatility (risk), having a risk profile of 4 in a range from 1 to 7, where 1 is the lowest risk and 7 is the highest risk. The fund invests in both active and passive strategies (at a 51%/49% ratio as at 31 July 2020), with the investment managers free to allocate their assets based on their experience, skill and analysis, alongside the group’s robust investment process. The investments are combined together in different proportions by Architas based on risk profiles set by an external risk modelling company (EValue Investment Solutions).
Fund overview
Source: State Street, as at 31 July 2020.
Management team
Sheldon MacDonald Deputy Chief investment Officer
Mayank Markanday Senior investment manger
Architas MA Blended Intermediate fund Performance
Past performance is not a guide to future performance. The value of investments can go down as well as up and your client may not get back the amount they invested. Total return figures are calculated on a single pricing basis with net income (dividends) reinvested. Performance figures are shown in sterling. The fund performance figures are net of all fees. Transaction costs are included for the period shown but may differ in the future as these costs cannot be determined with precision in advance.
To view the full range, or for more information visit: www.architas.com
Launch date 12.11.2001
Fund size £562m
Base currency GBP
Yield 1.55%
Annualised 5 year net volatility 8.51%
Legal structure Open Ended Investment Company
Architas MA Blended Intermediate S Acc
-2.85%
5.37%
5.75%
9.81%
10.57%
Architas MA Blended Intermediate Fund S Acc
