The Importance of Multi-Asset Investing by Nathan Jaye, CFA.


Everyone knows that
multi-asset investing
is on the upswing.
“Assets managed in
such strategies are
growing at one of the
fastest paces in the industry worldwide,”
says Pranay Gupta, CFA, formerly chief
investment officer for Asia at ING
Investment Management and manager of a
global multi-strategy fund for Dutch
pension plan APG. In their new book
Multi-Asset Investing: A Practitioner’s
Framework, Gupta and co-authors Sven
Skallsjö and Bing Li, CFA, set out to
answer questions about which practices
and ideas actually work. In this interview,
Gupta explains how the relentless quest
for alpha has made allocation an under-
appreciated and “under-innovated” skill,
shares insights into replacing asset
allocation with what he calls “exposure
allocation,” and discusses why the
standard model for making investment
decisions has “exactly the wrong
emphasis from a portfolio risk and return

Nathan Jaye, CFA: Why is multi-asset
investing so popular now?
Pranay Gupta, CFA: If you look at
investment management today, all plan
sponsors, consultants, and asset
managers — and even individual portfolio
managers and analysts — are all
structured with an asset class
demarcation of equities or fixed income.
We have equity portfolio managers and
fixed-income portfolio managers. We have
equity analysts and credit analysts, and we
have equity products and fixed-income
This industry structure worked well
historically, as equity and fixed income
were not highly correlated and allocation
to these two asset classes could result in
a diversified portfolio and you could earn
risk premiums. It made sense. But over
the past 10 years, the correlation between
asset classes has increased. Financial
engineering has created products which
are in the middle of the traditional asset
classes — hybrid products across equity,
fixed income, and alternatives.
So a clear distinction doesn’t hold true
anymore. The rising thesis is that we
should be looking at our portfolios as
multi-asset-class portfolios. That’s caught
on over the past few years. Assets
managed in such strategies are growing at
one of the fastest paces in the industry

What’s covered in your book?
The field of multi-asset investing is just
beginning its journey of innovation. This
book is meant for the professional
investor, and every chapter in the book
has a number of ideas which are different
from what I’ve seen across the industry.
In the first chapter, we cover the traditional
model — the way the world has performed
with traditional asset allocation in the past
five or six decades. In the remainder of the
book, we examine individual components
of the traditional allocation process and
show how each facet of the allocation
structure can be improved. These
techniques are applicable at multiple levels
— from a plan sponsor portfolio, sovereign
fund, or pension plan making a strategic
asset allocation decision to a hedge fund
managing a macro strategy. They are all
multi-asset investment decisions. Even
individual retirement accounts are multi-
asset portfolios, where allocation is done
across asset classes.
There are two types of innovations in this
book. One is at the conceptual level,
where we discuss the broad concepts of
how we should structure multi-asset
portfolios. The second is at the
implementation level, where we detail
innovative techniques, such as allocation
forecasting processes and managing tail
risk and designing stop losses. Some of
the chapters are intensely quantitative and
others are conceptual and qualitative.

Does asset allocation get enough respect?
We’ve all known for a long time that asset
allocation is responsible for the majority of
portfolio return and risk. It’s well accepted
that, say, 80% of the risk and return of the
portfolio comes from allocation and only
20% comes from security selection. But
when you look at the structure of the
industry, the resource deployment is
exactly the reverse — that is, 80% of
industry professionals are stock selectors
and bond selectors. Less than 20% are
involved in allocation.
The whole of the industry’s focus has
been the search for alpha. It seems quite
odd, given that alpha only drives 10% to
20% of the return and risk of an asset
owner’s portfolio. As I started managing
various kinds of multi-asset portfolios, it
led me to question the traditional process
of asset allocation, and I began exploring
methods to try and improve what is
conventionally done in a 60/40 balanced
portfolio or a strategic or tactical
allocation decision.
The importance of allocation has been
grossly underestimated, and allocation is
an under-innovated skill. In our book, we
detail a number of innovations we have
created and tried, but there are probably a
lot more that can be made. Unlike security
selection, where there’s been a lot of
innovation and progress made as a result
of the number of people focusing on the
skill. But not many people are focusing on
allocation skill.

Are organizations misdirecting their
If you look at any plan sponsor, you
normally have a very small team which
does the asset allocation and puts it into
asset classes. Then you have an army of
people who go and hire and fire dozens of
managers and perform due diligence on
them. This is exactly the wrong emphasis
from a portfolio risk and return standpoint.
We take great pains in selecting multiple
managers for diversifying alpha, but the
asset allocation in the plan sponsor is
done by a single group (i.e., a single
strategy done at a single time horizon).
We don’t diversify our allocation
methodology. We don’t harness time
diversification. What if we did exactly the
opposite? Suppose we took 80% of the
resources in the plan sponsor and
dedicated them to multiple ways of doing
allocation and manager selection was just
effectively a side effect?
In the book, we demonstrate how creating
a multi-strategy structure for the
allocation process and not focusing on the
implementation as much can lead to a
better portfolio. Discussions such as
active versus passive strategies or the
usefulness of fundamental indexation and
smart beta then become somewhat

What’s your experience in managing
multi-asset funds?
I managed a global multi-strategy fund for
APG, the Dutch pension plan, from 2002
to 2006. We grew the fund from a very
small base to a multi-billion-dollar fund.
Over this period, we experimented with
many different techniques of how to
manage large, multi-strategy, multi-asset
funds. Subsequently, when I was chief
investment officer for Asia at ING
Investment Management and Lombard
Odier, we implemented a lot of these
techniques in managing an asset base of
about US$85 billion across all asset
The traditional way one arrives into an
allocation function is as a
macroeconomist or strategist. But I
happened to stumble into allocation after
managing each asset class separately
from a bottom-up perspective. Having
gathered the real ground experience in
managing every single liquid asset class,
as the team size and asset size became
larger, I got thrust into managing the
allocation, risk, and portfolio construction
of these multiple strategies in a
combination. This was the perfect
breeding ground for innovation.

What’s your definition of commoditized
beta and non-commoditized beta?
We have been guided repeatedly to
separate alpha and beta in our strategies,
and told that we should strive for alpha.
Actually, alpha and beta are very alike;
they are both return distribution of assets.
The only difference is that beta can be
gathered by inexpensive derivatives which
provide exposure to specified factors
(such as market cap, value, etc.), while
alpha as a collection of exposures is not
available with such instruments. This
distinction keeps evolving as more and
more alpha exposures today become
available as beta exposures in a liquid,
inexpensive form.
I call what is hedgeable “commoditized
beta.” Equity market risk is completely
commoditized by an equity future. As
more and more betas are available in a
cheap, liquid, derivative form, they become
commoditized. The remainder are non-
commoditized and are classified as alpha.
So in managing portfolios, we propose
that, instead of doing asset allocation,
what if we do exposure allocation, where
exposures are in multiple dimensions, not
just equity beta and credit beta? If you
allocate to this richer set of exposures to
construct a portfolio, you enhance
diversification where it is required most.

You argue that the definition of equity risk
premium should be adjusted for allocation
purposes. Why?
The academic way of justifying investing in
equities is by the concept of the equity
risk premium, which is the long return on
equities above a risk-free rate.
But if you have a portfolio which includes
both equities and fixed income, the actual
reason you would invest in equities is not
the return on equities above cash but the
return on equities above bonds. Look at
this from a company’s perspective. A
company has the option of raising capital
through debt or equity. When a corporate
treasurer looks at how he should raise
capital, he evaluates whether it is cheaper
for them to take on debt or to raise more
equity. Our proposal for portfolio
management is exactly within the same
context, except that we are maximizing
return, not minimizing cost.

How do you apply this in practice?
From an allocation standpoint, we want to
have mutually exclusive and ideally
uncorrelated buckets. So we separated
equity risk premium from credit risk
premium and from country risk premium
and cash. It is a laddered structure for
defining what risk premium is — in order
to build better silos for allocation.
Then we innovated the allocation process
itself. There’s lots of debate about whether
risk parity is better or fundamental
allocation is better. People have these
philosophical debates because they have
only one allocation process. In the
structure we’re proposing, this question is
obsolete because all of these allocation
methods will have value at certain points
in time. Because they would be
uncorrelated with each other, a framework
where we use all of them — in a multi-
strategy allocation structure — will give
the benefit of strategy diversification and
time diversification.
Risk parity will work at some point in time,
and so will fundamental allocation and
long-term risk-premium allocation. Let’s
use all of them as different buckets,
because you can do allocation in many
different ways. Debating which allocation
strategy is better is a misplaced

What is your idea for composing
consensus estimates for allocation
If you want to know the consensus
expectations or rating for any stock in the
world, there are plenty of databases out
there which will give you that information.
Similarly, for economic numbers, there are
databases which collate all the forecasts
from economists on, say, the US Federal
Reserve’s rate hike and how many people
are saying the Fed will hike and how many
are saying it won’t. You have a range of
views, but you also know the consensus.
But there is no database available today
which collates the views of different sell-
side strategists on recommended
allocation stances. Every sell-side house
has a strategy team which allocates
across countries and sectors and
currencies, just like they have corporate
research analysts for earnings, but no one
collects their views and puts them in an
organized manner.
If allocation is important, then why don’t
we do that? These strategists are putting
out reports, but there’s no database which
collects all this information and uses it to
say, “Here’s what the consensus allocation
to this kind of sector or country is.”
Surely that would have value, just like
company earnings estimates have value.
How should firms structure a multi-asset
As multi-asset investing is becoming
more important, every asset management
firm has gone on a rapid increase to
bolster its capabilities in this area. But
everyone has done it very differently.
Everyone has a different take on what
multi-asset means. In the book, we
highlight the different approaches that
“multi-asset” can mean.
Firms should be clear about how they are
positioning their multi-asset business.
What are the capabilities that you need to
have? And what is beyond your capability?
You can’t be all things to all people.

Why do active managers investing in
Asian equities underperform relative to
active managers investing in US equities?
We compared active managers in Asia
against active managers in the US. The
data suggest that in the US, roughly half
the managers underperform and half the
managers outperform their benchmark. In
Asia, more than three-quarters of active
managers underperform and only about a
quarter outperform. And of that quarter,
less than 10% outperform on a three-year
basis. So the quality of active
management in Asia is very poor
compared with the US.
To understand why, we analyzed possible
sources of returns for active management
to exploit in both markets, and we found
that approximately 82% of returns in US
equities come from security selection —
only 18% of returns can come from
allocation decisions. In Asia, 66% of
returns can be attributed to the allocation
decision, not from stock selection. Yet if
you talk to most active managers in Asia,
most of them will tell you, “I’m a stock
selector. I go and pound the pavement
and pick stocks in each of these different
Our hypothesis is that active managers in
Asia are focusing on the security-selection
decision, which is a smaller source of
returns in Asia, and ignoring allocation
decisions, which is the bigger source. If
two-thirds of the returns in Asian equity
markets are coming from allocation and
active managers there are largely ignoring
this decision, then maybe that’s the
reason why the majority of active
managers in Asia underperform.

When you analyzed manager skill versus
luck, what did you find?
In 2007, when the quant crisis happened,
there were managers who were on the ball
and decreased risk on the day when the
meltdown happened in August.
But because they decreased risk (which
was the right decision), they didn’t
participate in the rebound the next day and
ended up with a negative August 2007
performance number. Managers who were
on the beach and didn’t know what was
happening — and didn’t actually do
anything to their portfolios — rode through
the week and had a positive return. But
that was return purely by luck.
Differentiating skill from luck is the most
important part of judging the value added
by an active manager.
In the book, we propose a framework for
how active managers can analyze their
own portfolio decisions and examine which
of their decisions are skilled and which
ones [are the result of] luck (which may
not repeat itself).

How important is the management of tail
risk in multi-asset investing?
If you look at most of the risk parameters
we use in modern portfolio theory, they
are based on the concept of end-of-
horizon risk — that is, if you hold an asset
for x months or x years. When we
calculate the volatility of that asset, it’s
based not on what that risk would be
across the period but on what it would be
at the end of the period. The practical
reality — for both individuals and
institutions — is that the intra-horizon risk
is a much greater determinant of
investment decisions while you are
invested in any asset. The current portfolio
management framework largely ignores
Suppose you buy something and it goes
down 50%. There is a real impact on how
you will behave towards that investment,
and that impact is a real risk which needs
to be accounted for. In fact, in many
countries, the regulator will come and tell
you to de-risk the portfolio and sell that
asset if you go beyond a specified asset
liability gap at any point in time. But none
of our risk parameters actually capture (or
account for) intra-horizon risk.
So we went about creating a new risk
measure, which is a composite of intra-
horizon and end-of-horizon risk. We did
this for each asset in our portfolio. That
changes the way one looks at the risk of
any asset, or the risk of the overall
Then we applied it to defining custom
stop-loss levels for decisions at every
level — at the asset level, sector level, and
asset class level. We found we were able
to manage portfolio drawdown much more
effectively, and it helped us a great deal
practically in managing with real intra-
horizon risk.

You’ve found that manager compensation
can incentivize portfolio blow-ups. How?
The conventional wisdom is that a hedge
fund compensation structure (where the
asset management company gets 20% of
the upside) aligns the interests of the
asset manager and the asset owner. It
seems logical that they say, “I don’t make
money unless you make money.” That’s
how it’s sold — the performance fee
creates the alignment.
But when we looked at how performance-
fee incentive structures change the
behavior of portfolio managers, we were
surprised. We found that there is a greater
propensity for the manager to take
excessive risk when the portfolio starts to
underperform. When we played this
behavior out over time and examined what
happens to the portfolio return distribution,
we found a scenario with outperforming
funds at one end and funds which blow up
at the other end of the spectrum.
The performance fee incentivizes these
blow-ups. Our hypothesis is that while
performance fees can incentivize
alignment of the upside, they’re also a
significant determinant of why hedge funds
blow up.

How has your approach to multi-asset
investing evolved?
I didn’t set out to write a book. All of
these chapters have been written over the
past 10–12 years. As I managed
portfolios, I started coming across
problems where the traditional solution
seemed inadequate, and I thought there
was room for innovation. My co-authors
and I started experimenting and tried to
find novel solutions. The book came about
over the past six to nine months as we
finally set about collating everything we
have done over the past decade and
making a cohesive argument. Everything
in the book is actual solutions we
implemented to practical issues we faced
in managing portfolios.
This article originally ran in the March
2016 issue of CFA Institute Magazine.


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