Low cost multi-asset funds more volatile in down markets

17 Oct 2018

Investors in low cost multi-asset funds are more likely to experience higher volatility when markets decline, according to new research by Zenith.

In its 2018 Multi Asset Diversified Review of 88 rated funds, Zenith compared the performance and drawdown of a low cost group in the growth category with a management fee below 0.58% per annum, and a higher cost group with fees above this amount.

There has been a significant increase in recent years in the number of low cost multi-asset funds in Australia, due to the increased sensitivity regarding management fees particularly in a low yield environment.

Despite both groups achieving similar returns over the past five years to 30 June 2018 (8.5% and 8.4% respectively), there was a more pronounced difference in investment risk. The low cost group suffered a worst loss (drawdown) of 6.4% compared to 5.1% for high cost funds.

Much of the difference in downside protection can be explained by the comparative allocations to alternatives between the two groups. In the five years to June 2018, low cost funds maintained an average 0.8% allocation to alternatives, while their higher cost counterparts averaged a 6.8% allocation. Alternative investments sit outside mainstream asset classes and often use derivatives to help perform in both rising and falling markets. This typically comes at a higher cost compared to other asset classes and therefore, are often not included in low cost funds.

Zenith Head of Multi Asset Andrew Yap said “while investor interest in low cost funds is likely to remain elevated in a low rate environment, we caution against selecting products based solely on cost considerations.”

The Zenith Report highlights three differences in the way low cost funds are constructed and managed, including a lower allocation to alternatives, less active asset allocation and increased weightings to asset classes that have a higher prevalence of low cost structures such as ETFs and passive funds. 

Yap said “investors need to be aware that these fundamental differences can impact relative performance between the groups and affect risk and return outcomes, despite low and high cost multi-asset funds having a similar label presented to investors.”

The Zenith report also states that in times of low volatility between asset classes, performance between the two groups may be more likely to converge. However, at market extremes Zenith would expect the higher cost group to outperform and show stronger capital preservation qualities.

Financial advisers have continued to support multi asset funds as they offer a turnkey solution that satisfies their ‘best interest’ obligations, particularly for investors with small balances.

Source: Zenith Investment Partners

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