Sort by lowest price

Price is what you pay, value is what you get. Our multi-asset investment specialist, Craig Brown, is looking for a new car and is wary about the risks hiding under the bonnet.

30 March 2021

I’ve come to the point where I can hold off no longer: my little car that could is getting on a bit and no longer can. It’s time to search for a replacement.

It’s hard to get excited about. I don’t need a sports car, just a reliable vehicle that does the straightforward, and rather unglamorous, job I need it for. Luckily, I don’t think I’ve reached a mid-life crisis quite yet, so I’m not aiming to look like Vin Diesel (with more hair and fewer muscles!). Living by the sea I’d probably go for a jet ski if that were the case anyhow!

To aid my search there are lots of handy filters that help make this a less painful task. One I never select though is “Sort by lowest price”. This isn’t because I am a slightly younger – but equally bearded – Logan Roy, for whom money is no object. It’s because, like my Dad once told me, you get what you pay for.

Just because the cheapest car on the website hasn’t broken down in the last 10 years, doesn’t mean something won’t go awry in the next decade. Often the cheaper the product, the more problems that seem to lurk just below the surface.

This follows in the investment world too. Many people have been drawn to using solely passive multi-asset approaches for their investments because they are the cheapest option and the last 10 years of data show they haven’t broken down. However, I believe there are significant risks lurking under the bonnet of these fund ranges.

The nature of passive multi-asset approaches can embed biases in how portfolios are structured. This is down to the passive instruments they buy within the funds, which all track various indices.

Passive multi-asset funds use tracker funds which follow stock and bond indices. While this keeps costs down, it makes them totally beholden to what those indices look like. Take government bonds: these bond indices tend to be spread across the whole universe, so they have sizable amounts of interest rate risk, often called duration. This makes periods of rising bond yields, as we are seeing now, very painful. The more rate risk you hold the more your bond index falls as rates rise. More active funds, that buy specific bonds, can reduce the amount of duration they take on, making them more flexible.

Meanwhile, there are similar problems in stock markets. After years and years of outperformance, ‘growth’ companies have swelled as a proportion of US market indices. When we are searching for companies to invest in within our multi-asset funds, many of the companies who tick the boxes for us tend to fit within what most would call growth companies as well. However, we still have the ability to increase our exposure to other types of businesses when we feel valuations warrant it and to add more balance into the portfolio – this is something we work hard on to manage risks posed by swift market rotations. Tracker funds don’t have that luxury. This is another pitfall that active managers can assess and make a judgement call on, whereas passive options are obliged to walk right into it.

Active investors can steer clear of potholes

This lack of flexibility at the heart of passive multi-asset approaches embeds risks for investors. And these are risks that the managers can do little about. They are using instruments which are designed to track an index, so track the index they must, for better or worse.

Unlike passive funds, active multi-asset managers like us can work to limit some of these risks. You will pay a bit more, but at least if things begin to go wrong something can be done to correct the problem. We can adapt and attempt to avoid some risks that passives simply can’t. At a time when government bonds yields are being pushed higher, we can – and have – pivoted to other assets for protection and been more creative in managing our risk. Similarly, where our funds have overseas exposure we have actively hedged currencies to protect our investors from the rising pound, and can then unwind those hedges when we deem it appropriate. Passive multi-asset strategies typically don’t provide this protection.

Placing all the proverbial eggs in the passive basket opens investors up to risk that is hard to manage all for the sake of cost. Market environments can change, and sometimes materially so. Having a portfolio which can adapt to those changes is surely worth paying that bit extra for. After all, price is what you pay, value is what you get.

That’s enough procrastinating for me. It’s time to get on with the task at hand: using those filters wisely to find a trusty vehicle that will see me through all sorts of terrain.