It has been more than four years since the Investment Association launched the Volatility Managed sector. Its purpose, its director of capital markets Galina Dimitrova said at the time, was to “reflect the advent of more outcome focused products”.
Today, the sector is popular with financial advisers and retail investors. It attracts average inflows of more than £250m a month and is home to funds managing more than £50bn in total. Of the 50 months that have passed since launch, only one (March 2019) has seen negative flows.
However, with funds adopting different investment styles, and with underlying holdings often indistinguishable from a traditional multi-asset approach, how can advisers navigate the sector to meet clients’ needs?
The birth of outcome-focused funds can be traced to the 2008/9 global financial crisis, when unforeseen and severe market volatility led to huge investor losses.
Against this backdrop, an appetite for funds which stood a better chance of providing investors with both an acceptable investment path and a satisfactory outcome emerged. This heralded an influx of funds that focussed, not on asset bands, but on risk parameters and variations of returns.
From day one, funds within the Volatility Managed sector varied in approach and investment style – an IA disclaimer at the time of launch pointed out that “timeframes and methodologies for management of volatility may vary from fund to fund”.
That was in 2017, and the sector has evolved since then.
Managers’ early approach was to target a percentage of the historic volatility of an index – 50% of MSCI World, say – with a perimeter either side. However, the disadvantages of assessing past volatility alone quickly became clear – consider for example the wild gyrations in markets during the early part of the Covid-19 pandemic. In short, recent history told managers little about how returns vary during investment terms, and it is telling that few funds use this approach today.
Next was to consider the expected variations of returns during the life of an investment using (at the time) modern statistical methods. The combined forecasts of the future volatility of individual assets were then used to build efficient portfolios, which benefitted further from the rise of stochastic modelling.
From here, managers’ focus shifted once again, this time from the journey to the outcome. Today, advanced statistical techniques are used to simulate a ‘best’ investment return and to then try to keep the variability of outcomes down. This is where investors’ time horizon becomes significant to the asset blend: after all, some assets such as bonds may be volatile during their lifetime but offer a degree of certainty on outcome.
If you are ever looking for an analogy to help explain this approach to clients, you could use the game of darts. When a dart is thrown, it will wobble as it flies (if you have ever seen a dart’s flight in slow motion, you will know what I mean). This reflects a clients’ investment journey. When darts hit the board however, they rarely hit the same spot, but are spread out (particularly if like me you are not very good). This illustrates the spread of investment outcomes.
The differences between a Volatility Managed fund and a traditional 60/40 portfolio may not, on the surface at least, be obvious.
You will find similar asset classes including elements of property and commodities. You will witness tactical asset allocation strategies overlaid on strategic allocations. You will find both approaches face similar challenges, such as on responsible investing, active v passive, and the effects of interest rates and inflation.
However, Volatility Managed funds’ advantage is their laser focus on investment journeys and outcomes. This allows advisers to offer an investment solution which benefits from expected investment efficiency and which can be matched to clients’ risk profiles over the medium to long term.
On 5 November 2021, Embark Investment reclassified its Horizon fund range from the Investment Association (IA) Mixed Investment sector to the IA Volatility Managed sector, and changed the funds’ asset allocation guidelines and Prospectus.
The funds’ new home better reflects their outcomes-based approach, while the change to the guidelines allows for greater investment flexibility. Find out more about the changes at embarkhorizon.co.uk/changes-to-funds-prospectus/
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