Institutional investors are wrestling with big challenges in strategic allocation today. Expected returns for stocks and bonds are low, causing asset owners to look beyond traditional asset classes to meet their objectives. Regulatory oversight and fee pressures are rising, supporting a massive shift from active to passive strategies. And secondary investment objectives, such as yield or environmental, social and governance (ESG) considerations, are growing more important.

A diversified portfolio that includes multiple asset classes and strategies may be able to address these challenges, but it can be a tall order to design, implement and adapt such a solution. Current industry practice is to set asset-class targets and then allocate active risk to the managers within each asset class. However, this approach may limit the range of diversifying strategies evaluated. And it may make it harder to spend fee budgets on the most attractive alpha opportunities.

What’s more, the returns of many off-the-shelf investment products are actually a package of different return sources, so investors may end up paying for return drivers they don’t want. This could lead to a buildup of common risk exposures, making it harder to manage portfolio drawdowns.

Designing a Better Multi-Asset Framework

Multi-asset solutions have the flexibility to invest in a wide range of strategies that cut across traditional asset-class silos, creating a single, cohesive strategy.

In our view, because of their potential to employ an unconstrained opportunity set, fully integrate return sources to efficiently target outcomes, and manage risk dynamically, multi-asset solutions should make up a growing part of institutional portfolios.

But it takes a mix of science and art to design an effective multi-asset solution. Fundamental judgment informs quantitative tools; the insights from these tools help identify current controversies.

Essentially, science and art are integrated in order to:

• Identify the return building blocks (Display) that form the foundation of a multi-asset solution. These return streams should be persistent and uncorrelated with each other.

• Assess the risk-adjusted return potential of each building block above that of stocks and bonds, as well as its ability to diversify and reduce losses.

• Use portfolio-construction tools to combine return sources and tailor solutions to satisfy a diverse set of investment guidelines and portfolio outcomes.

• Employ flexible implementation and dynamic risk-management tools to make sure portfolios efficiently access required exposures and avoid a buildup of common risks.

As we see it, getting both the science and art of multi-asset investing right will be the key for investors to meet their long-term return objectives and weather the next major market downturn.