Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Sheldon MacDonald, Manager of the Architas Multi-Asset Blended range.
Hi, Sheldon.
Sheldon MacDonald: Hi. How are you?
Wall: So, multi-asset is a really interesting space. We seem to be having a lot of fund launches recently as people increasingly look to outsource the very difficult job of asset allocation. One of the reasons it's become so difficult is because the two sort of traditionally opposite ends of the scale, equities and bonds, have become more correlated thanks to various different macro reasons such as quantitative easing, et cetera. So, how do you look for or create an uncorrelated diversified portfolio in this increasingly correlated world?
MacDonald: You're right. It is an issue for investors to be thinking about. It obviously is something we're thinking about all the time. First of all, why is it a problem? So, you need diversification to iron out the journey, the investment journey that you take.
If you're in an old style portfolio which mandates specific weightings and specific asset classes, as the correlations between those asset classes increase, the volatility of your returns is going to increase. So, as an investor you need to be looking for sources of diversification if the traditional sources aren't working.
Now, the portfolios we run are risk targeted which means that we can be more flexible with our asset allocation in order to try to maintain a level of risk that the investor has signed up for initially. What can we do within those portfolios when the volatility is increasing because correlations have risen? Well, we can look at cash. Cash is the ultimate diversifier. But by going into cash all you're really doing is diluting your returns. Cash doesn't deliver you anything, certainly not after inflation. So that would only really be a short-term solution.
So, what else can you do? You can look to various changes within the traditional asset classes. So, there are some absolute return funds that will still invest in equities or in bonds to try to deliver your fairly constant return stream. But what we've increasingly started looking to is some alternative funds that we're using in the portfolios.
Wall: What do people mean by alternatives? Because it's a very blanket phrase, isn't it? If you look at the alternative sector in The Investment Association, you have lots of different things under that umbrella term. What alternatives do you use?
MacDonald: Sure. It is very much a catchall and by its nature it is particularly diverse. There's funds offering anything from catastrophe risk through to property which is almost a mainstream asset class. So, we use it simply anything that isn't a conventional equities fund, a conventional bond fund, a conventional property fund or a cash fund.
Wall: Are alternatives more risky than stocks and bonds? Because I think a lot of people associate alternative with commodities, for examples, which have not had a great couple of years. So, are alternatives risky?
MacDonald: I think it's understandable why people think they might be. Used correctly we think they are a source of diversification. So, each individual fund that you use might be as volatile or perhaps even more volatile than an equity fund or a bond fund, but because they are giving you that diversification what they are doing is reducing the overall level of risk that you have in your portfolio.
As I said, it's understandable because they are new, they are different. People don't necessarily understand what the investment drivers are, what the return drivers are. But that's why people like us in the industry are there to help, to try to explain what these funds can do and to use them correctly in a portfolio context.
Wall: Sheldon, thank you very much.
MacDonald: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
