James Gard: Euro allocation funds have been underperforming their benchmarks for years. Here to discuss why is Se Manager Research Analyst, Thomas DeFauw. Thanks for joining us, Thomas. You published a piece called Multi-Asset Investing: A Difficult Sport. Can you explain why it is a difficult sport?
Thomas DeFauw: Hey James. Thanks for having me. Yeah, it is a difficult sport. Of course, there's multiple ways to look at multi-asset portfolios. The classic way is to compare them to a blended benchmark of stocks and bonds. And if we look at it this way, euro allocation funds have clearly struggled. For example, the moderate allocation category underperformed by more than 2 percentage points per year over the last 10 years. And the main reason for this underperformance is simple. It can't be stressed enough, but it's fees. So basically, 60% of the underperformance is caused by fees. Last year, my colleague Matias Möttölä and I have zoomed in on this aspect and discussed cheaper alternatives that investors have, like building your own portfolio. But in this report that we discussed, we tackled the other factors that drive returns. So multi-asset investors, they have to take a lot of decisions. First, there's the allocation between stocks, bonds and cash. Then there's the choices within each asset class. You might favour value over growth or up or down your duration or credit quality in the bonds sleeve.
JG: Thanks for that. And you're saying home bias is also quite a pertinent factor as well.
TDF: Yeah, exactly. I mean, many decisions add up to results, of course. And then home bias is a clear example. So, we've seen that European multi-asset managers often have more allocation to European stocks. And those have been a detractor versus the benchmark, which holds a higher allocation to US stocks. That is the allocation part. If a strategy uses actively managed underlying strategies, there's an additional layer of security selection within each sleeve that fund buyers also have to consider.
JG: Sure. You talked about strategic and tactical asset allocation decision-making. Can you give us an idea of the takeaways from that?
TDF: Yes. So, the main driver of returns is what we call strategic asset allocation. So simply put, this is the target allocation between stocks, bonds and other assets. There are some managers that rebalance their portfolio close to those targets. And there's also those that have more leeway to have more flexibility to adjust allocations as they see fit.
JG: Sure. So that's strategic. What about the tactical side of it?
TDF: Yeah, it's interesting that you mentioned that. What we typically see is that the call for dynamic or tactical portfolio positioning, so that's where the manager frequently changes the portfolio's allocation in anticipation of price fluctuations, that call typically rings louder after a period of high volatility, like we've seen in 2022. But like many researchers before, we've struggled to detect multi-asset managers that master this art of tactical allocation over long cycles. And even in 2023, we didn't see many market timers shine.
JG: Sure. Yeah, that's not surprising really. So, what would you say is the main takeaway of the report as a final roundup?
TDF: Yeah, I guess one of the main observations and perhaps lessons to investors is it's really important to understand the strategy, the investment process, the promises that are made by managers and to see if strategic asset allocation and/or security selection is the dominant driver of performance or whether tactical trading plays a role. And then finally, perhaps some nuance to the story, there are a great many, what we call, objectives oriented funds, for example, multi-asset income that makes distributions or ESG funds that have goals beyond financial returns. So, in these, there's a specific investment outcome to consider. And all the work that goes into achieving those goals is not always captured through the benchmark relative performance.
JG: Sure. So, you would say overall, there's still a role for allocation funds in some investors' portfolios if they choose wisely?
TDF: Absolutely.
JG: Excellent. Well, thanks so much for your time today, Thomas. For Morningstar, I'm James Gard.
