Multi-sector funds are adopting new flexible investment strategies as the traditional risk-based approach to strategic asset allocation comes under challenge, according to a recent Morningstar report.

The report found that one of the by-products of the recent market volatility and poor returns from growth assets such as shares, has been the advent of a new multi-sector investment strategy collectively known as 'objective-based approaches'.

Objective-based approaches focus on the most appropriate asset class or mix of assets to meet a particular investment objective. 

The traditional approaches of risk, return and correlation characteristics are secondary considerations, the report said.

Under the new objective-based strategy, investment managers have greater flexibility in asset allocation than traditional approaches and do not generally have a strategic asset allocation from which to deviate.

For example, the traditional strategic asset allocation for a fund is normally 60/40 split in growth and income.

However, funds that use an objective-based approach can invest up to 100 per cent of their assets in defensive assets as well as 77 per cent each in growth and alternative assets.  The Schroder Real Return Fund is one fund that adopts this approach.

"This kind of flexibility provides both opportunities and risks.  The investor is essentially relying on the fund manager's judgements, as the portfolio is likely to be concentrated heavily in certain areas," the report said.

It also found overall flows to multi-sector funds were negative over the year to September 2011.

The bulk of the outflows occurred in the quarter after 30 June 2011 with $1 billion withdrawn, nearly all of it from the multi-sector growth funds.

"Many investors were spooked by developments in Europe and fled to the perceived safety of cash. Investors may have used the start of the new financial year to reconsider their risk profile and investment allocations, anecdotal evidence suggesting that cash and term deposits have been the repository of this loss of confidence," the report said.