Legal & General Investment Management
From the mail bag: putting fund managers on the spot
John Roe and Andrzej Pioch, Legal & General Investment Management
For professional investors only. Capital at risk.
John Roe, LGIM’s Head of Multi-Asset Funds and Andrzej Pioch, Lead Fund Manager of the L&G Multi-Index Funds answer some of the top investment questions put to them by financial advisers
Why take investment risk when cash offers 5%+ return?
[JR] This comes up a lot in our conversations with advisers. After so many years with low interest rates, cash may seem intuitively a lot more appealing.
Less investment risk can now be taken to achieve a given level of target return. However, that could change rapidly in the future if the Bank of England cuts rates. As an alternative, investors could consider holding government bonds to maturity, essentially locking in higher bond yields we see today.
If an investor’s assets are such that they can afford to take less risk by solely investing in cash and bonds and still achieve their goals, and they’d rather prioritise that than seek higher long-term returns, then we can see why it might work. However, when we speak to advisers what we hear is that lots of savers aren’t in that position.
Some of their clients have too little and still want to seek higher long-term returns, for example for a better retirement. Others have goals that are less clearcut, so even if they could achieve their immediate goals with lower risk cash and bonds, they’d still like to have more upside potential in the future.
That’s why we still see a lot of interest in multi-asset funds and it’s worth remembering that these funds should already reflect the change in market conditions. For example, the bonds they hold now offer higher yields.
Of course, we might get future conditions that sees cash outperform equities, but it would be unusual on a long-term basis, as taking investment risk would be expected to be rewarded. Can we get an easier one next please?
Why do you believe active asset allocation adds value, surely the same arguments for passive approaches apply there as in single asset classes?
[AP] Fundamentally, we believe that the structures of economies and markets change, and so asset allocations should too. After all a lot can happen in 5 or 10 years, for example just look at quantitative easing and then the current rate hiking cycle.
To adapt a quote from Keynes, “when the facts change, we change our minds”.
Asset allocation changes can still be gradual though. What we’re worried about is larger, structural changes, not every little piece of news that buffet markets in the short term. We’d agree that the decision on how active to be is more subjective – a trade-off between trying to add value and the potential for higher fees and other costs from buying and selling within the funds we run.
With sustained higher inflation, do investors need to diversify away from bonds?
[JR] Our team motto is ‘prepare don’t predict’. And we believe that’s particularly true with inflation. Economists and central banks have a very poor record of guessing where it will go.
2022 was a great example of course, with bonds performing very badly and multi-asset funds, particularly those on the lower end of the risk spectrum, struggling more as a result. In 2023 so far, it looks like bonds are providing better diversification to equities, with performance more similar to the decade before 2022. But it’s early days in the inflation fight and we believe it’s essential to accept how uncertain it could be from here.
In our funds, we generally own more bond exposure that 12 months ago. That’s primarily because with higher starting yields we think there’s more potential for them to help us in a bigger equity and economic downturn. It’s really important to remember that government bonds gave positive returns even in the 1970s recessions, when inflation was rampant!
The bond additions haven’t been extreme though, mainly because we accept inflation uncertainty. If it’s surprisingly sticky then central banks will need to do more and we could see another bout of bond and equity weakness as a result.
Alternative assets like infrastructure and global real estate equities are having a tough time. Why continue to bother with them?
[AP] Alternatives add complexity for the fund manager and to the adviser, compared with a simple portfolio of equities and bonds. So, we’d agree they need to really justify their role.
The reason we include them in our Multi-Index funds is that we think they’re exposed to somewhat different economic drivers. For example, on forestry the long-term cashflows that drive investor returns will be a function of wood prices. Similarly real estate is all about the commercial property cycle, which often doesn’t coincide with the standard economic cycle.
As with everything, cost implications remain crucial too so we have to try to access them in ways that aims to mitigate the drag for investors. This means we often access them via index-based allocations. In some cases though, where we feel it’s more appropriate we’ll design a basket of holdings ourselves.
2023 hasn’t been good year for alternatives, in comparison with equities. But of course, that’s all part of diversification where the whole idea is that assets have different drivers and so hopefully perform at different times.
Click here to find out more about LGIM’s Multi-index funds
Key Risks
The value of investments and the income from them can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance. It should be noted that diversification is no guarantee against a loss in a declining market.
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