The role of Active and Passive funds in multi-asset portfolios
Adrian Gaspar, Investment Director at the M&G Treasury & Investment Office (T&IO), provides some thoughts on why Prudential use both active and passive funds within multi-asset portfolios.
The debate on the merits of active and passive investing has raged on for many years and various forces have combined to build a huge groundswell of support for passive funds of all types in recent years. Within Prudential multi-asset portfolios both are employed, and for differing reasons. Indeed, the company now offers both the LF Prudential Risk Managed Active and LF Prudential Risk Managed Passive ranges that sit alongside the PruFund range.
The rationale for this short piece is to give some clarity on why we use both. I think it is worth caveating that within T&IO and across the business we believe in active management. The vast majority of Group AUM is in active funds, vehicles, mandates. However, passive vehicles can be extremely helpful in building low cost portfolios which provide efficient and liquid access to a broad set of asset classes.
The role of Active funds in Prudential multi-asset portfolios
There are numerous ways of building a multi-asset portfolio. Ultimately if a multi-asset fund delivers on its objectives and meets the client's aspirations then there is no right or wrong combination of underlying investment vehicles. We believe using active funds in portfolios can produce long-term, steady and positive returns for clients over the full business/investment cycle.
LF Prudential Risk Managed Active Range
These portfolios have been doing just this for many years. The wide variety of fund types within most IA sectors provides ample choice and combinations of fund management styles and approaches. If blended well, they can provide healthy returns across different market conditions. Whilst we largely use internal active managers and teams such as M&G Investments and M&G Real Estate within portfolios, external managers, such as Royal London and Legal & General, are used to complement them. The alternatives holdings are also external managers and the ambition is to onboard at least to two more teams from outside M&G to run new equity positions in Africa and China.
PruFund portfolios also have exposure to many specialist and private asset classes. Due to the nature of some of these assets it would be impossible to replicate using passive vehicles. You may be able to get a very broad exposure to areas like property, private equity and infrastructure but this would introduce extra volatility as the holding would be more exposed to changes in short-term investor sentiment.
Within PruFund portfolios there’s the added benefit of being able to work with underlying active managers through the design and objective setting within the segregated mandates. The Investment Management Agreement (IMA) is key and it is often a collaborative effort between T&IO and the fund manager.
T&IO Manager Oversight
All underlying manager selection and monitoring across Prudential multi-asset portfolios, whether collectives or PruFund, is undertaken by the T&IO Manager Oversight team. This is a hugely time consuming and resource intensive process. The team is 8 strong with a powerful combination of skills and experience. They’ve created a very robust framework that underpins their due diligence process.
This will include very detailed quantitative analysis but more importantly a very in-depth qualitative overlay, where detailed RFPs are completed and fund managers, senior leaders and various people across a fund group will be interviewed to gain a deeper understanding of all the moving parts of a business and how they all interact. Clearly, the goal is to select managers that can add value over the longer-term while being mindful that active managers, however good they are, will experience periods where the gyrations of capital markets are not in their favour.
Talented fund managers, who can meet and beat their objectives do exist. We believe good active managers have the skill and flexibility to avoid fads, or overvalued stocks or sectors/countries that are unattractive whilst being able to take advantage of opportunities that they can identify or sell holdings when they feel value has been achieved.
Market anomalies do occur and in early 2020 shares in many countries were sold on fear, with no assessment made of the strengths and weaknesses on many companies. Volatility in stock markets will always exist and whilst this can provide a bumpy ride for investors it can also provide opportunities for active managers to buy assets at very attractive prices.
The role of Passive funds in Prudential multi-asset portfolios
The project undertaken during 2018 to re-engineer both Prudential multi-asset collectives ranges saw the launch of the LF Prudential Risk Managed Passive Range 1-5 in January 2019. This work very much reflected the hunger for diversified multi-asset portfolios, that were still actively managed but with the underlying building blocks being primarily passive vehicles. The key outcome to using passive vehicles is of course lower charges. The Ongoing Charge Figure (OCFs) for this range being 25/26bps.
LF Prudential Risk Managed Passive Range
The selection of passive vehicles allows the portfolios managers to gain very efficient and cost-effective access to most of the asset classes selected through the strategic asset allocation process.
So, what helps drives the costs down?
In Prudential portfolios, we employ large, well establish vehicles that track broad market indices. They may have a lead fund manager to oversee operations but there is little human input and minimal investment decision making. So, no need for investment committees to make stock, sector or regional investment decisions and no analysts to provide ideas for the fund manager.
The core underlying holdings are iShares funds and whilst cost was key, this does not mean manager due diligence was not required. Indeed, whilst ongoing monitoring is less onerous than for an active fund the Manager Oversight team will still need to assess tracking errors, rebalancing and stock lending policies (if applicable) for example.
Are the Risk Managed Passive portfolios purely passive?
No. The portfolios are required to hold at least 70% in passive vehicles but an interesting nuance to them is the use of active funds. The reason being that our active capabilities across alternatives and fixed income will add value over time, hence the use of four M&G bond funds and a variety of listed and actively managed vehicles in private equity, hedge funds and infrastructure. As with the Active range, new positions in Africa and China will also be actively managed.
Being able to leverage off internal capabilities was also helpful in keeping overall costs within the figures referenced above.
There is a place for active and passive funds in portfolios for a number of reasons. The evolution of both in recent years now means better choice as passive funds offer very broad coverage and active managers know they have stiff competition from low-cost entrants to the market, so need to continue to strive to deliver the potential for strong returns but at a more competitive price.
The evolution of the adviser market over recent years and the downward pressure on costs has led to a wave of new product development, with businesses ensuring they have a wider range of solutions to meet investor requirements.
It’s not about active v passive anymore, there is demand for both. The challenge is to understand the adviser market and build solutions that have a clear philosophy about where they invest and why, are easy to understand, with the potential to produce good returns and are priced such that they represent good value for money.
This environment should be good for advisers but more importantly their clients.
The value of any investment can go down as well as up so your client might get back less than they put in.