Embedded Biases in Multi-Asset Funds

By Paul Ilott, Scopic Research

Multi asset funds have embedded biases and we need to know about them

If you’re an adviser or paraplanner who recommends multi asset funds as part of your investment company’s proposition to clients - whether this is in the form of an outsourced or in-house centralised investment proposition, or whether you simply recommend multi asset funds generally - then you need to know about embedded biases in multi asset funds.

Why do we need to know about embedded biases?

Firstly, because without exception, all multi asset funds have them, and secondly, if you understand embedded biases, then it will give you some key advantages:

1. It will give you an edge when it comes to determining client suitability.

2. At the point of recommendation, it will help you prepare your clients for the investment journey. You’ll be able to tell them when a particular multi asset fund is likely to perform well and when it might find conditions more challenging.

3. It will enable you to have better informed discussions with your clients about performance when it comes around to annual client reviews.

4. It will help you to be more tolerant of periods of perceived poor performance when a multi asset fund’s embedded biases suggest that this is probably what you should expect given the market environment.

5. It will enable you to be more justifiably critical of performance when a multi asset fund’s embedded biases suggests that it should have performed rather better than it did.

So, what are embedded biases?

Embedded biases effectively describe the DNA of a multi asset fund. In our experience each multi asset fund is very likely to have its own unique DNA.

Embedded biases, and therefore a multi asset fund’s DNA, can be found in many ways:

1. Its intended investment outcome or sometimes its multiple intended outcomes

2. Its likely volatility temperature relative to broader equity markets

3. The types of underlying product structures and asset classes you can expect to see and the extent to which each of them is used

4. How complex the fund is to understand

5. Its geographical reach, how its investment team addresses and assesses ESG related risks

6. Its dominant investment styles and the average size of company within its equity holdings.

All of these have a bearing on client suitability and the likely pattern of the investment journey and, knowing about embedded biases can contribute towards you meeting your consumer duty responsibilities.

So, we would say that when it comes to selecting multi asset funds, it shouldn’t only be about understanding the likely level of volatility risk, the cost, or even about whether a fund is active or passive.

Finally, the DNA offers another advantage when it comes to blending multi asset funds together into one larger client portfolio, because it can help us to diversify, rather than to compound, different DNA characteristics and sources of potential risk and return.

Multi Asset DNA reports can be accessed for free by NextGen members at www.scopicresearch.co.uk.

Please use the code ‘NextGen’ when you first register.