What’s in a name?

Last week I sat on a panel answering the questions of a group of GCSE students considering a career in financial services. One of my pearls of wisdom was to be different, think independently and never be afraid to challenge the status quo if they want to flourish against the threat of AI. Not sure if I inspired them or scared them off to be honest, but at least they were given a dose of realism.

We were asked to introduce ourselves and give a quick summary of our careers so far. As mine began 40 years ago, that was some task! I told them my first investment job was in 1984 as a dividend clerk, having been transferred from the banking department after I failed as a records clerk.

They clearly had no idea what a clerk was. Today, I would have been an income collection executive (or perhaps just an excel worksheet), after transferring from being a client accounts facilitating manager (a website enquiries form).

We often see how things are bestowed new names to give the impression of modernity or more intrinsic worth. There’s nothing inherently wrong with this, I guess, although today you end up with some bizarre job titles. And after years of little wage inflation, we’ve definitely had job title inflation: US companies seem to be running out of ways to describe vice-presidents with minutely stratified seniority.

This is also true for products and services in the investment world. Model portfolio services are sold as a form of discretionary fund management and often referred to as bespoke solutions. Clearly, bespoke and models are as different as tailored suits and those bought off the rack. The latter should be significantly cheaper, as they’re made in bulk to suit as many people as possible. Yet they may not be the best option, unless you’re the standard fit. I am not saying a model is bad, but it should never be the default option.

Aligning labels with investors’ expectations

In my world, I get frustrated at the way any strategy with more than one asset class is defined as multi-asset. Although in the strictest definition this is true, I feel it’s very misleading and causes confusion among clients and regulators.

How has this come about? Well, since time immemorial both institutional and private client investment managers have managed ‘Balanced’ strategies, most often benchmarked against a composite set of market indices. The most famous of all being the 60/40 (equities/bonds) model. Note the word model again.

Again, there’s nothing wrong with this approach. The client picks the benchmark and the manager attempts to outperform (achieve alpha) by making allocations that are different to the benchmark. Passive managers invest in line with the benchmark and will structurally underperform by the level of the annual fees compounded. Of course, many active managers also underperform, so manager selection is key.

A true multi-asset approach, however, does not involve the use of a composite benchmark to set strategy. Instead, the manager targets the maximum return for a stated level of risk which matches the investor’s risk profile. Typically, the investment strategy is set by collating a portfolio of assets to achieve optimal returns on capital invested. That is, only the investments that meet the risk/return criteria make it into the strategy; there is no under or overweighting versus a benchmark. The manager has no benchmark asset allocation to guide him/her. This is why, in my opinion, there’s no such thing as a pure passive multi-asset fund.

I have often thought that a client who gives a manager a composite benchmark has taken most of the long-term asset allocation decisions themselves, letting the manager off the hook to a certain extent. The benchmark becomes the investment objective, rather than purely a measure of ability (or luck).

The Rathbone Multi-Asset Portfolio and Rathbone Greenbank Multi-Asset Portfolio funds that my team manage adopt a risk budget and then try to maximise the return from the investment universe available. This often means major asset classes are left out, such as investment-grade corporate bonds in years gone by when they offered paltry yields. So, I think our investors are guaranteed active management as if you have no benchmark asset allocation, there’s no chance of closet tracking. It does compound the importance of manager selection though: clients have to trust us to get it right and we must deliver.

The problem with multi-asset is that you need to offer a number of risk profiles, as one size definitely does not fit all. That’s why we now have five risk strategies in our ‘stable’, along with nine other portfolios that offer different currencies, domicile, income and sustainability. They are all managed individually from a bottom-up (security selection) and top-down (asset allocation) basis to ensure each uses its respective risk budget to the maximum efficiency.

Balanced (both passive and active) and multi-asset approaches can all be appropriate for different people, though my conviction is obviously in the latter. I do believe it’s time to distinguish clearly between the two and make it easier for buyers to make a suitable and informed decisions and to assess value.

By the way, we’re not escaping scrutiny by avoiding a benchmark. Funds/models can be monitored across all approaches using Sharpe or Sortino ratios, a way of ranking the best risk-adjusted performance. I believe these are the most relevant for our investors in any event as they speak to their return needs and their attitude to risk. This is why we named our podcast The Sharpe End.

Model portfolio services are not bespoke discretionary fund management services and balanced (relative to benchmark) strategies are not multi-asset (targeted return) strategies. All can be relevant for a client, but we need to be more precise in how we describe them so people can work out how they address their needs and the value of each approach, not just its price.

Anyway, it is time for me to carry out my duties as customer host for remotely situated executives seconded to Chez Coombs, i.e. take a cup of tea up to Tracey’s office.

Tune in to The Sharpe End — a multi-asset investing podcast from Rathbones. You can listen here or wherever you get your podcasts. New episodes monthly.