In its Multi-Sector Funds Sector Wrap-Up Morningstar explained alternative investment approaches including objective-based investing, tactical asset allocation funds and lifecycle funds re-adjust their asset allocations over time, sometimes aggressively, meaning that any change can affect the overall portfolio’s risk profile.
Morningstar senior research analyst Brook Sweeney said while objective-based investment strategies aim to provide capital protection they are “no magic bullet”.
Unlike strategic asset allocation (SAA) strategies, Mr Sweeney said objective-based funds often don’t have a set strategic allocation, meaning they may “venture into risky assets to augment performance numbers, or may be restricted from using their full flexibility due to their time horizons”.
Mr Sweeney also noted that although objective-based strategies tend to be well diversified to reduce volatility, this can mean substituting growth for more defensive assets.
“While this may give the appearance of a more risk-constrained portfolio, often managers ratchet up the defensive allocation within riskier equity-correlated securities, such as hybrids or high-yield bonds, to obtain higher returns,” said Mr Sweeney.
“In tough economic conditions, these funds can suffer in the same way a more aggressive SAA strategy might.”
In regard to tactical asset allocation funds, Mr Sweeney said these strategies face the “formidable challenge of accurately timing markets”.
“A string of poor calls can hurt performance and frequent switching in and out of assets can make this approach transaction-heavy and erode portfolio returns,” he said.
“High turnover can also increase taxation costs.”
The one-size fits all approach of lifecycle funds, he said, also has its challenges.
While this approach may have some benefit for those super fund members lacking the motivation to manage their portfolios, “it doesn’t account for their unique circumstances, such as individual savings or retirement goals”.
Mr Sweeney also argued lifecycle funds do not account for the present value of future wages and the speed at which a lifecycle fund move to more conservative assets may not be suitable for everyone.
