The trend in recent years has been away from multi-asset funds, towards MPS. A report published in June by the consultancy NextWealth showed that  £123bn was held in discretionary MPS portfolios at the end of March, up from £71bn in 2021. Assets in multi-asset funds stood at £174bn, down from £179bn at the end of March 2021.

A recent report from Aegon, however, shows that multi-asset funds continue to be the option of choice for most financial advisers. Aegon found that 90 percent of advisers questioned are using them for both accumulation and decumulation. 

Another recent report examined the returns of more than 1,000 multi-asset MPS portfolios against equivalent funds. Over both three and five years to the end of June 2024, MPS portfolios on average outperformed funds in four out of five of Morningstar‘s UK multi-asset sectors.

Over a five-year period, MPS solutions outperformed funds by an average of 2.4 percentage points across the five sectors.

Both MPS and funds can work

But how informative are comparative studies? Surely both MPS solutions and multi-asset funds have the potential to provide excellent, and, for that matter, dreadful, investment outcomes? What really makes the difference is the type of strategy. Is it a low-cost, long-term, rule-based strategy? Or is the strategy dictated by fund managers making active decisions and charging higher fees? 

An example of a sensible MAF option is a Vanguard LifeStrategy fund, with a simple asset split between equities and bonds depending on the client’s risk profile.

However, when financial professionals talk about multi-asset funds, they are usually referring to actively managed funds where the portfolio manager makes strategic decisions to trade assets across multiple asset classes, and not just stocks and bonds.

The problem is tactical allocation 

Investors, and indeed many financial advisers, are easily seduced by the notion of so-called tactical asset allocation (TAA), and fund houses are very clever at promoting the idea of “nimble” fund managers having the flexibility to “go anywhere” and dip in and out of different assets depending on the latest information. 

But there is overwhelming evidence to show that, in most cases, TAA doesn’t work.

The limitations of tactical asset allocation were highlighted in a study by Fundhouse published in May this year. Researchers analysed 160 multi-asset strategies in the Investment Association’s Mixed Investments 40-85% Shares sector that had at least a five-year track record, many of which were run on a 60/40 basis.

Fundhouse compared the sample to two 60/40 benchmarks, rebalanced twice a year, one with a UK home bias and one without. For the 40% bond allocation, they used a global aggregate bond hedged to a sterling index. For the equity element with a UK home bias, they used a 15% UK, 45% global ex-UK blend, and for the equity element without a UK home bias, they used a standard global equity index.

What the researchers found was that, over ten years to the end of March 2024, fewer than 15% of the 160 funds they looked at outperformed the fully global benchmark, and fewer than 20% outperformed the UK-biased benchmark.

Why tactical allocation usually fails 

The Fundhouse study clearly shows that passive strategies work best. But why should that be? Why is tactical asset allocation so hit and miss?

The researchers suggest two possible explanations. First, say the researchers, “we are wired to have a brake pedal that is bigger than our accelerator… The instinct to err on the side of caution may cause fund managers to reduce risk too soon and add it back too late”.

Secondly, “asset allocation in most multi-asset strategies is heavily influenced by macro insights and forecasts. Our research suggests that the odds of getting these forecasts consistently right are very low.”

Cheaper is generally better

So, is the answer for advisers simply to use an outsourced MPS instead?

Not necessarily. Because, as with MAFs, when most financial professionals talk about MPS, they’re usually referring to old-style discretionary fund management — actively managed and expensive. Advisers should be using one of the newer MPS solutions instead as they are usually cheaper.

This huge cost advantage of passively managed MPS solutions inevitably translates into superior performance — even over shorter time periods.

This was recently illustrated by the financial data provider Defaqto, which compared the performance of model portfolios categorised as “adventurous” over the three-year period to the end of May 2024. 

Remarkably, nine out of the top ten portfolios were passively managed. 

Lessons for advisers

The key takeaway for advisers is to ask the right questions. What matters most is not whether you go with MPS and MAFs, but how the assets are managed and how much your clients will pay.

The fundamental design fault with most multi-asset funds, and indeed with most MPS solutions too, is that they are actively managed.

In the long run, very few active managers will outperform the market through tactical asset allocation with any consistency. What’s more, identifying those managers in advance is extremely hard.

The case for using low-cost, evidence-based investment solutions is irrefutable.

Robin Powell is editorial consultant at Sparrows Capital