Blending active and passive to manage risk

Since the financial crisis, risk management has become increasingly important to investors.

Santander Asset Management’s Atlas Portfolio range provides an intelligent solution to this challenge – each fund in the range is designed to provide returns that are managed to a specific risk profile.

Over-exposure to a particular investment style is a risk that is often ignored by asset managers. The Atlas Portfolios seek to achieve their return objectives while adhering to their volatility profiles by investing across a range of different asset classes. Not only does the proportion of each asset class vary according to the risk profile of each portfolio, but the funds chosen within each asset class are also selected to match that risk profile.

Too many multi-asset funds adopt a binary approach to selecting passive or active managers within each asset class – it’s either all active or all passive. Blending both strategies allows managers not only to access active manager talent while minimising costs, but also to mitigate investment-style risk.

Most passive equity funds track indices that are weighted by market capitalisation. As a result, passive products tend to be highly sensitive to price movements and tend to perform well in a bull market.

In contrast, an active manager looks for long-term value when selecting the stocks for the portfolio, rather than those stocks that have simply performed well recently. Actively managed funds are therefore less likely to perform well in bull markets.

A multi-asset fund that chooses to have only all passive or all active managers will have an over-exposure to one particular investment style. Conversely, a fund that invests in only active managers will be able to capture the long-term benefits of, for example, a growth or value strategy, but will not perform as well during bullish market conditions.

Across other asset classes, blending both active and passive approaches helps to reduce risk – this can be done for fixed income and for certain alternatives, as shown in the Atlas portfolios.

It’s possible to invest in fixed income using passively managed bond indices and actively managed funds. Like equity indices, bond indices have a bias – sovereigns or corporates with the highest level of debt will be overly represented in the index.

These indices are therefore more exposed to increases in default risk. In contrast, active bond managers tend to make their stock selection based on creditworthiness – they try to avoid those issuers with a higher default risk.

Although blending active and passive strategies within a certain asset class can help to mitigate risk by offsetting differing performance across market cycles, Santander Asset Management does not assume this will always be the case.

Before selecting a fund, the team will carry out a thorough analysis to ensure the funds will help meet  the returns necessary  within the specified risk parameters, given different market conditions.

This analysis of the impact of blending passive and active managers on the overall risk profile of the portfolios illustrates the thorough approach taken by the Atlas Portfolio investment team. By designing a solution rather than a product, the adviser has an off-the-shelf tool – whatever the risk appetite of the client. And the client has the reassurance that every aspect has been considered to ensure their risk targets are not breached.

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