Multi-asset funds can help mitigate the asset allocation risk for multi-manager portfolios, according to Standard Life Investments.

Many Australian superannuation funds use multi-manager models, in which the investment decisions are outsourced per asset class to a manager.

And although most funds have clear guidelines as to how much of a portfolio can be invested in growth assets and defensive assets, based on the investment options they run, there is often some leeway as to how much is invested in a certain asset class at a particular time.

These decisions were often made by a relatively small team, Standard Life Investments multi-asset investment director David Millar said.

"Asset allocation risk in any super fund, or any pension fund, is the most predominant risk that a fund will take, and in some cases that risk is taken at the whim of one person or a couple of people rather than using the expertise available in the marketplace to contribute to that asset allocation debate," Millar said in an interview with Investor Weekly.

This risk is potentially on the rise as more super funds bring parts of the investment management process in-house.

Multi-asset funds could be used to mitigate the risk by carving out a part of the total portfolio and running it in addition to the multi-manager portfolio, Millar said.

Funds have also been considering allocating to multi-asset funds as part of their alternative exposure.

Standard Life's multi-asset fund, the Global Absolute Return Strategies fund (GARS), was designed as a pension product, Millar said.

"The history of GARS is that it was developed as an in-house solution for Standard Life's own pension fund. It was introduced as a whole fund solution, where 100 per cent of the assets were in GARS," he said.

"But it has the potential to go all the way from being an allocation in an alternative bucket to being a whole-of-fund solution."

The fund's design addresses the problem of dealing with severe shocks in markets and this is especially important in a defined contribution market like Australia, where members are allowed to stay invested in growth assets in the pension phase.

"It is interesting that in the Australian market the post-retirement is almost as critical as pre-retirement," Millar said.

Modelling of portfolio balances shows balances are potentially at their greatest at between five years before retirement and 15 years after retirement, as most of the investment returns are earned in the later stages of accumulation and early stages of retirement.

"In the Australian market, where members can stay invested for longer, that post-retirement phase is absolutely critical," Millar said.

"When you add a drawdown event to that, you could shorten the duration of the fund by a substantial amount.

"A 15 per cent drawdown in retirement means your fund could run out seven years earlier."

Standard Life Investments' multi-asset fund has been running as a product available to external clients since 2006.

The fund delivered far less volatile returns than an average balanced fund.

During the global financial crisis, the fund lost 5.9 per cent in 2008, against an average balanced fund loss of 14.3 per cent.

Similar results were found during the 9/11 attacks and the 2010 euro sovereign crisis.

The lower volatility of the fund also meant that it has not reached the same heights during bull markets, but since 2006 the fund has still returned 9 per cent a year, when calculated in British pounds.

The fund multi-asset character gives it a larger degree of flexibility and this allows the managers to capitalise on opportunities, while avoiding the more risky investments depending on the market environment.

In the current environment, Millar pointed out, for example, that bonds were not a defensive asset.

"Every person, as an individual or a fund, who is relying on bonds as a defensive assets needs to question that investment," he said.

"Can you still rely on government bonds to deliver positive returns when yields are so low?"

He said despite the gloomy outlook for growth and yields there were still instruments managers could use to cushion the portfolio against falls.

For example, volatility could be a defensive asset, he said.

"There are other defensive assets in the world: volatility, equity volatility, currency volatility," he said.

"Volatility in equity markets has come down quite far; the implied volatility is quite low.

"But if you have volatility in your fund, then should the market drop quite sharply, that volatility will compensate you for that."

The most straightforward measure of volatility is the VIX Index, potentially with the help of options, but he said managers could also use variance swaps, which were swap contracts based on the implied path of volatility.

"These are the outright directional ones," he said.

"Then we also have strategies that we call relative value. Here you are looking for relationships between different strategies; for example, large cap/small cap in US equities.

"We favour large-cap over small-cap equities; there is a fundamental theme in there that we believe large caps will do better because the nature of this sluggish recovery benefits those with the capacity to access capital and cut costs." 

The team also develops potential shock scenarios and looks at how to insulate the portfolio against them.

For example, it has looked at the implication of a collapse of the Chinese stock markets, where equities would fall an average of 75 per cent.

"Having an absolute return focus, we have nowhere to hide, so we continuously look for our weak points," Millar said.