Outcome-oriented multi-asset investment solutions January 2018 This document is for investment professionals only and should not be distributed to or relied upon by retail clients. It is only intended for use in jurisdictions where the relevant investment vehicles are authorised for distribution or where no such authorisation is required.
Combining multi-asset absolute return funds to target tailored risk and return outcomes
A practical solution for calibrating expected risk and return in client portfolios in a consistent manner Multi-asset absolute return funds, each with different return and risk objectives, can be combined to target a wide range of specified risk and return outcomes. However, the blends are likely to be most effective when the component funds share an investment philosophy and process, with consistent investment views held across the underlying portfolios. Otherwise the perceived benefits of blending could potentially result in lower than expected diversification (for example through opposite and offsetting currency or interest-rate positions). What makes a multi-asset absolute return approach different from other multi-asset funds? A multi-asset fund is one that holds several different types of investment, with the intention of diversifying portfolio risk and mitigating the effects of market uncertainty and economic crises. Traditional multi-asset funds sometimes described as balanced or mixed seek to lower risk by investing across a range of familiar asset classes typically equities, bonds and real estate. Investor outcomes will be driven by the returns of these asset classes. This approach has been effective historically during the ups and downs of markets as bonds provided an effective risk balance to equities and other growth assets. However looking ahead, with many core fixed-income markets expected to deliver lower returns relative to recent history, such an approach may not be best-suited for the future. Other types of multi-asset funds that aim to deliver diversified growth from mainly traditional asset classes may also be vulnerable. History shows that, in severe market downturns, traditional assets tend to move in unison. Clearly, this type of fair weather diversification has only limited value. Standard Life Investments multi-asset absolute-return approach We seek to improve on traditional diversification methods, building portfolios that are genuinely and durably diversified. The objective is to provide a more predictable outcome for investors. The approach provides considerable downside protection in weak markets and a less directional outcome relative to both equity and bond markets. To achieve this, our advanced methodology differs from traditional multi-asset approaches in several crucial respects. Unconstrained by an index benchmark, we have freedom to invest in an exceptionally diverse investment universe. So, alongside traditional investments we take positions that allow us to seek returns from our views on interest rates, inflation, currencies, volatility and cross-market relative value. Our ability to take long, short and relative value positions means we can seek positive returns across a wide range of market conditions. We select investments that have potential for positive returns and for their diversification benefits, improving both the risk profile and the return opportunity of the portfolio. Our advanced multi-asset absolute return solutions are outcome-oriented, meaning we target a cash+ return, aiming to minimise risk as we seek to deliver that return. Rigorous and effective risk management is at the core of our multi-asset approach and our quest to build genuinely and durably diversified portfolios. Our multi-asset funds benefit from our established and proven risk management expertise, processes and infrastructure. The origins of our multi-asset absolute return capabilities As pioneers in multi-asset investing, we have extensive experience managing multi-asset portfolios, with a proven investment process, effective risk infrastructure and an award-winning multi-asset investing team. Our multi-asset absolute return capabilities evolved from the need to tackle the funding deficit in our own Standard Life staff pension scheme. The advanced multi-asset, absolute-return solution we devised in 2005 became known as Global Absolute Return Strategies or GARS. Such was its effectiveness, we launched it as a standalone vehicle for institutional investors in 2006, retail investors in the UK in 2008 and to global investors in 2011 through our SICAV SLI Global Funds.
Building on the success of GARS and in direct response to client needs, we have designed a range of absolute return, outcome-oriented portfolios, offering a choice of performance profiles. For each fund, our objective is to achieve the specified return target, and minimise risk to generate consistent, low volatility performance, although we cannot eliminate risk altogether. Our multi-asset absolute return solutions Recognising investors different return objectives and risk tolerance levels, our solutions offer a choice of risk/return profiles. The table below shows their key features. Note there will be periods when a fund delivers more or less than the target return shown below, and it may even lose money these are not capital protected funds. Tailoring our solutions to meet client objectives We recognise that every investor may have a different risk and return objective. Clearly, we cannot create an individual fund for each client. However, by enabling the funds in our range to be blended in different proportions, we can offer additional flexibility to advisers and professional investors to allow them to target their own specific risk-reward requirements. They can do so in the knowledge the components they are using are based on a robust and consistent investment framework. Absolute Return Global Bond Strategies (ARGBS) Target return Cash* + 3% evaluated over rolling 3-year periods (gross of fees) Global Absolute Return Strategies (GARS) Cash** + 5% evaluated over rolling 3-year periods (gross of fees) Global Focused Strategies (GFS) Cash** + 7.5% evaluated over rolling 3-year periods (gross of fees) Overall objective ARGBS aims to deliver a positive absolute return in all market conditions through a diversified range of fixed income and currency strategies. GARS is a global multiasset strategy that aims to deliver a positive absolute return in all market conditions. It seeks returns through dynamic allocation to macro investment opportunities. GFS aims to deliver a positive absolute return in all market conditions through a multi-asset approach that integrates macro views with micro insights. Expected risk Lower downside risk than global bonds, 2% to 4% expected volatility range 1/3 to 1/2 of equity market risk, 4% to 8% expected volatility range 1/2 to 2/3 of equity market risk, 6% to 12% expected volatility range Realised volatility since launch annualised*** 1.9% 4.2% 4.9% Ideas universe Bonds and FX Macro Multi-Asset Macro Multi-Asset Macro and Micro Diversification potential High High High Typical number of strategies held 20-30 25-35 20-40 * We define cash as 3-month EURIBOR **We define cash as 6-month EURIBOR *** ARGBS Gross; SICAV vehicle launched 30/03/2011 ISIN D Eur Class LU0548158830 GARS EUR Gross; SICAV launched 27/01/2011 ISIN D Eur Class LU0548153955 GFS EUR Gross; launched 12/12/2013 ISIN D Eur Class LU0995142212 Realised volatility figures to 31 December 2017.
To demonstrate how our absolute return funds can readily be blended to suit a client s needs, the charts below show how GARS and ARGBS can be used in varying proportions to target a range of risk and return profiles. Chart 1 and Table 2 illustrate the historical performance of these combinations. Table 1 below details the make-up of the blends. Table 1: Targeting risk and return* objectives with combinations of absolute return funds Combination Expected level of return Expected annualised volatility range Weight in ARGBS Weight in GARS Blend 1 Cash +3.0% over 2-4% 100% 0% Blend 2 Blend 3 Blend 4 Cash +3.5% over Cash +4.0% over Cash +4.5% over 2.5-4.5% 75% 25% 3.0-5.5% 50% 50% 3.5-7.0% 25% 75% Higher risk and return potential Blend 5 Cash +5.0% over 4-8% 0% 100% 100% ARGBS 100% GARS * Gross of institutional share class fees (0.60% for ARGBS SICAV and 0.85% GARS SICAV) Chart 1: Absolute return combinations historical performance 135 130 125 120 115 110 105 100 95 90 2012 2013 2014 2015 2016 2017 2018 Blend 1 Blend 2 Blend 3 Blend 4 Blend 5 Analysis based on historical performance: Blends based on realised historical returns of GARS and ARGBS Over 6 years of live track record for both funds Provides a perspective on past behaviour of absolute return combinations since March 2011 Return statistics Ann. Ret. Volatility Max. DD. Blend 1 0.9% 1.9% -2.7% Blend 2 1.6% 2.2% -2.2% Blend 3 2.3% 2.8% -3.5% Blend 4 2.9% 3.5% -5.0% Blend 5 3.6% 4.2% -6.7% Net of institutional share class fees (0.60% for ARGBS SICAV and 0.85% GARS SICAV) Historical net performance of combinations of ARGBS SICAV and GARS SICAV institutional share classes Cumulative returns shown assume frictionless monthly rebalancing (blends 2, 3, 4) Source: Bloomberg, Standard Life Investments, 31 March 2011 to 31 December 2017
Table 2: Analysis of historical performance of combinations based on realised returns* 2011 (31 Mar - 31 Dec) 2012 2013 2014 2015 2016 2017 Blend 1 1.5% 1.4% 3.1% 0.7% 1.4% 0.3% -1.9% Blend 2 2.0% 2.9% 3.9% 1.9% 1.8% -0.6% -1.0% Blend 3 2.4% 4.4% 4.8% 3.1% 2.2% -1.4% 0.0% Blend 4 2.9% 5.9% 5.7% 4.4% 2.5% -2.3% 0.9% Blend 5 3.3% 7.5% 6.5% 5.6% 2.9% -3.2% 1.9% * Net of institutional share class fees (0.60% for ARGBS SICAV and 0.85% GARS SICAV). Historical net performance of combinations of ARGBS SICAV and GARS SICAV institutional share classes. Cumulative returns shown assume frictionless monthly rebalancing (blends 2, 3, 4) Source: Standard Life Investments, 31 March 2011 to 31 December 2017. We can also use modelling to simulate the expected behaviour of the different blends and their constituent elements, based on our forward-looking scenario analysis framework that enables us to estimate the impacts of potential shocks to markets extreme but plausible events that have never happened before. In the following examples, we show the expected outcomes for Blend 2 (75% ARGBS + 25% GARS) and Blend 4 (25% ARGBS + 75% GARS) in a range of extreme situations, both during historical stress episodes and forward-looking scenarios. The work is based on our propriety risk methodology which we apply to our absolute return funds. One advantage of using the scenario approach is that this approach does not rely solely on the specification of a theoretical model. Chart 2 shows the expected drawdowns for Blend 2 and Blend 4 in historical episodes and potential future stress scenarios. The results suggest that these particular combinations of GARS and ARGBS are expected to produce drawdowns well below those we would expect from comparable reference risk-assets in a range of adverse scenarios. Considering the expected levels of return of the blends in relation to ranges of expected maximum drawdowns we would envisage, these blends can provide an attractive level of return relative to risk. Creating solutions from our individual funds offers an efficient and effective means of defining a specific performance target. Moreover, it does so in a way that takes account of both clients return expectations and their tolerance of risk. These illustrations use GARS and ARGBS. We could target different return objectives with blends including GFS.
Forward-looking scenario analysis preparing your portfolio for the unknown unknowns While historical stress scenario analysis is now a well-established approach in tail-risk management, there is less consensus on how best to perform forward-looking scenario analysis. In modelling future scenarios, the framework we have developed combines investment judgment with quantitative discipline. Effectively, this means incorporating expert opinions about future world states into projections of portfolio outcomes. We can mathematically derive the estimates we are seeking through a process known as maximum entropy. This exercise is carried out across a range of different stress situations that are plausible but extreme, economically rational yet unlikely. It is important to recognise that the value of successful scenario analysis should not lie in the exact specification of portfolio gains and losses in a specific scenario the results should be intuitively correct but not spuriously accurate. Rather, its benefits lie in the process and interaction it enforces. Ultimately, forward-looking scenario analysis is a tool to explore potential portfolio weaknesses, through the interactions of experts, who specify scenario shocks; risk managers, who model the inferred losses; and portfolio managers, who can use the results to challenge and enhance their intuitive understanding of the behaviour of their portfolios in extreme scenarios. In practical terms, the role of forward-looking scenario analysis in portfolio construction is to examine whether our current portfolios provide an acceptable level of protection in adverse left-tail events. Using a diversified multi-asset approach can effectively help mitigate losses in such extreme market scenarios. Chart 2: Forward-looking scenarios and historial stress scenarios 5 0-5 -10-15 -20-25 Forward-looking scenarios Historical stress scenarios 0-5 -10-15 -20-25 -30-35 China Crisis Italy-Triumph of Populists Disrupted Korea Stagflation China devaluation (10-25 August 2015) Euro Crisis (22 July - 23 August 2011) Bank Meltdown (12 September - 15 October 2008) Bond Sell-off (14 June - July 2003) Blend 2 High yield excess returns Blend 4 Source: Standard Life Investments, 30 September 2017 Global equities Conclusion We seek to build portfolios that are genuinely and durably diversified, in order to effectively mitigate the effects of market uncertainty and economic crises while still targeting an attractive level of return. Our portfolios benefit from our long experience in multi-asset management, proven investment process and effective risk infrastructure. The flexibility of our solutions means we can readily tailor them to suit the objectives and priorities of clients. If you would like further detail and insight into the modelling processes we use, including the risk and return outcomes of other blended portfolios, please speak with your product specialist or contact our local team.
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