The Science and Art of Multi-Asset Investing

The Science and Art of Multi-Asset Investing




by Martin Atkin, Managing Director, Multi-Asset Solutions Group, AllianceBernstein

Generating consistent returns under uncertain conditions is a challenge. Can multi-asset strategies make the job a little easier? We think so. But a lot depends on how they’re designed.

Institutional investors today are wrestling with strategic allocations in the face of a challenging environment. Expected returns for stocks and bonds are low. Regulatory oversight is increasing. There’s a massive industry shift from active to passive investment strategies. And additional investment objectives such as environmental, social and governance considerations are growing more important.

We think a flexible and well-diversified multi-asset approach can help. But there are a myriad of asset classes and strategies to choose from—traditional and nontraditional, active and passive, liquid and illiquid. There are also many approaches to designing such a solution.

In our view, a multi-asset solution has to do three things:

  1. Generate excess returns above an optimal mix of stocks and bonds
  2. Diversify an overall portfolio to ensure more consistent returns
  3. Limit volatility and protect investors against large drawdowns

But to be truly effective, multi-asset solutions need to be dynamically managed, unconstrained and fully integrated. Simply stitching together a number of single-asset strategies into one portfolio isn’t enough. What truly drives the returns of each building block? In which environments is it expected to be more effective or less effective? How do the pieces fit together and how do they alter the portfolio’s overall characteristics?

Assessing the Building Blocks: Historical Perspective

History is a good starting point in answering these questions—but it’s only a starting point.

The following Display compares the historical risk-adjusted returns of several building block strategies and asset classes, as measured by their long-term Sharpe ratios, with their consistency of return—in other words, how reliable is that Sharpe ratio over a given time period?

Each bubble represents multiple asset markets and sources of return. Global equities and bonds include all developed-world stock and bond markets. Smart beta includes several alternative strategies, including equity factor strategies that rely on specific quantitative measures, such as momentum or value, to calibrate exposures.

The chart includes both return sources that rely on broad market exposure, or beta, and those that rely heavily on alpha, or manager skill, such as hedge funds and tactical asset allocation (TAA) strategies. Of course, there are also other ways to incorporate alpha into an investment framework. For example, investors might implement actively managed strategies that rely on security selection.

Global stocks and bonds—the traditional pillars of asset allocation—sit comfortably in the middle. The risk-adjusted returns for the other categories are measured by what they deliver above and beyond these crucial building blocks. For example, real estate investment trusts have exposure to equity and bond risk as well as risk that’s unique to real estate.

At first glance, quantitative strategies such as smart beta, which create value by allocating to certain risk premiums, have delivered the best combination of return and consistency. TAA strategies, which temporarily adjust a portfolio’s long-term target weights to take advantage of short-lived market opportunities are at the other extreme, with a poor showing.

Building the Framework Requires Both Science and Art

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