Brexit shows why macro calls don’t work

Written by: Thomas Nehring
Nordea's Thomas Nehring argues that many multi asset funds have failed to provide their stated diversification benefits during the recent spike in global volatility.

After many years of a largely benign investment environment, heightened volatility has re-emerged in markets over the past 12 months. Investors in multi-asset funds are now starting to take notice.

Most multi-asset funds broadly have similar aims – delivering equity-like returns with lower volatility, while providing medium to long-term capital preservation. This is typically achieved by broad asset class diversification.

However, with consistent returns across asset classes with minimal volatility in recent years, the investment philosophies and processes powering many multi-asset funds have not had a chance to be truly stress tested. But this all changed 12 months ago.

The wake-up call for investors in the multi-asset funds space was the summer of 2015, with many funds facing acute stress. Between July and August 2015, coinciding with the Grexit fears and China’s hard landing scares, the multi-asset funds sector could not provide the much-needed and often-promised true diversification for capital protection.

This has continued to occur. Similarly poor capital preservation characteristics were on display during the highly volatile month of January this year, while the volatility surrounding the Brexit vote last month also caught many managers out.

The Morningstar EAA OE Moderate Allocation sector (EUR) – which houses some of the largest strategies in the multi-asset funds space – has on average fallen 4% over one year to 1 July 2016, with a maximum drawdown of more than 10%. So much for capital preservation!

The universe’s poor downside protection during volatile periods can be attributed to two main reasons. Firstly, many managers overestimated the potential of asset class diversification. In addition, many managers still make macro calls, which are extremely difficult to do in volatile conditions, and then allocate to assets to reflect these particular views.

But the good news for investors is not all multi-asset funds are created equal. At Nordea, we took a decision almost 10 years ago to shift our investment focus away from asset class investing – such as top down or directional/beta investments – to focus on return drivers, or risk premia. One of the primary reasons for this important distinction is that most asset classes can include several risk premia exhibiting significantly different characteristics over time, and by separating these we are able to run a much more robust correlation analysis.

This allows our Nordea 1 – GBP Diversified Return Fund to navigate through periods of severe market dislocation, such as the day after the unexpected Brexit vote. Our strategy was down only a few basis points on 24 June, despite the contribution from our developed and emerging market beta drivers delivering an almost 1% negative downside. This contribution was cancelled out by a number of positive return drivers – including our low risk equities, government bonds and FX strategies.

If volatility is here to stay, multi-asset managers must seek truly uncorrelated assets – instead of relying on the notoriously difficult task of repeatedly making accurate macro calls. Efficient diversification is not simply about piling into a number of asset classes, but rather the identification of a select number truly uncorrelated positions able to deliver for investors through all market environments.

Thomas Nehring is the head of UK & US institutional and wholesale distribution at Nordea

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