Covering the spectrum

Researcher Lonsec calls it the year of the multi-manager, and from some planner and investor perspectives ‘manage the manager’ funds appeal as the ultimate one-stop shop.

One of the major drivers for their popularity is that multi-manager and multi-strategy products can and do offer a diversification of style and manager with relatively low volatility.

And as financial advisers move to fee-for-service, the case for manage the manager funds (MTMs) continues to gather momentum.

The promoter mantra is that accurate calls on individual investments as well as rebalancing and selecting asset class allocations are best left to professional analyst teams, while advisers should focus on their own value proposition.

That said, not all MTM funds are equal, and because historically asset managers are behind these funds, having moved from consulting into implementation, not all research houses cover all products in their reviews. This makes it a little harder for planners to compare like with like.

VIEW ALL

View all

Lonsec’s recent research on the multi-manager universe gave only one fund — Russells — a highly recommended gong, while eight other funds received a recommendation only.

Lonsec said it was extremely impressed by Russells’ research team and experience and chief investment officer Peter Gunning says that while he’s surprised by the honours (Russells also won Money Management’s award for the second year running), the results flow from the breadth and depth of resources brought to the task.

“You need breadth of research to gain context, so that means seeing a lot of managers — approximately 6,800 meetings in a year — and we’ve got the depth; we spend over $30 million a year on analytical systems and research to look under the hood.”

The funds that drew their next level of recommendation included AXA Summit Select series, BT Partner Series, Skandia Global Access, Mercer Global, ING’s Optimix funds, MLC, InTech, and Challenger’s Custom Choice International share fund.

Meanwhile, Morningstar is currently in the process of reviewing the large cap multi-managers for Australian shares. However, previous reports agree with some of Lonsec’s findings.

For example, Optimix is recommended for its Australian shares and Emmanuel Calligeris and his team receive particular praise.

But in a 2005 report by Morningstar, MLC’s multi-manager strategy for Australian shares is “starting to look like a case of too many cooks spoiling a good broth”. At that point, there were nine sub-managers on board.

Several issues arose. Morningstar said the top heavy number of sub-managers was creating a trend to index plus capacity restraints on these funds also raised the question of how the money would be best used to maximise returns.

Also, Morningstar said MLC’s style-indifferent approach was unlikely to deliver substantial alpha — although not underperforming either.

This quasi-index criticism rather vexes MLC’s Chris Condon because he believes it fails to “get” their high conviction approach.

“The general idea is to neither be at the top or bottom quartile; rather, to minimise the down cycles and to deliver a reasonable and diversified return depending upon when you joined. This is primarily because of the way MLC’s nine sub-managers run their portfolios, and how these aggregate,” Condon says.

“When we look at our own portfolio of nine Australian equity managers, we find that the aggregate portfolio, at stock level, looks nothing like the index at all.

“For example, we measure ‘active money’ of portfolios, which is the sum of the positive positions against the index. It is one view of how different a portfolio is from the index. Over time, the active money component has increased, which is what you’d expect from high conviction portfolios.

“A few years ago, when you had News Corp leaving the index, the indexers suffered and so did many active single managers, who were left with an exposure for benchmark-relative reasons which they suddenly didn’t want.Our managers had a different approach. The whole event was irrelevant to them.

“What that means is that every position held is for good investment reasons and not just business risk management. The aggregate gives a good diversification and the best of both worlds.”

Dance of the managers

Just as the landscape for MTMs has refined since the 1980s, so too have practices and culture.

As a pioneering player, MLC has over $60 billion under management in its multi-manager portfolios and gives managers mandates, averaging between $1 billion and $2 billion.

Most managers stay for five to seven years and some, such as Capital and UBS, have been managers since inception.

Chris Condon points out: “When we hire, we take a view that the relationship is a partnership for the benefit of investors. But it’s not a marriage. One party, that is, MLC has responsibility for determining if the relationship continues or ends. We need to be close to the managers for a working relationship while remaining at arms length, and if other managers are better, then we will not hesitate to replace the incumbent.

“You have to select exceptional managers and you need sufficient scale so that doesn’t detract from performance; it’s a diminishing improvement but it’s still an improvement. You can continue to add managers if you have the scale and don’t start compromising on quality.”

Condon and Russell’s Peter Gunning both agree there’s plenty of manager talent to choose from with a healthy population of boutiques.

MLC uses concentrated portfolio approaches in it’s MTM line-up.

“One of the biggest changes is the misunderstanding of high conviction investing; it’s very tempting to say that we will get the manager to invest in a certain way and give them rules. The market has also evolved,” Condon says.

“Back in the 1980s, we were the only ones giving mandates outside of them [super funds]. These super funds tended to be less sophisticated and decisions were made by lay trustees.They generally hired two to three managers for each asset class. They would also be fairly strict and quite adversarial. The decision-making around that type of corporate governance was often flawed and lay trustees had the responsibility of selection and termination, being advised by asset consultants who had some knowledge but not the responsibility. So advice was often conservative and the arrangement didn’t actually look at the end investor. Maybe it didn’t facilitate the best job.”

Condon adds: “We have two driving principles when it comes to mandating managers. First, that the manager should be free to invest provided their actions comply with the product rules.

“Second, we give them freedom to act within the scope of their skill. This results in a liberal mandate and it’s a profoundly different to the way most institutions operate.

“Everybody is driven by incentives, and if managers believe they will be terminated if they don’t perform in three years, then they risk becoming benchmark-aware and focusing on their own business risk to the detriment of the investors.

“What we want from our managers is diversification of insight.”

So the idea of second-guessing the sub-managers charged with a mandate is no longer acceptable, according to Peter Gunning.

“There’s no danger of second-guessing stock positions; at the end of the day, we’re tasked with identifying good stock selectors … we’re not second-guessing fund managers’ positions. Managers want to get across a good story that the process is effective and works … the reason we have people who have run money before as portfolio managers is that they can sift through the marketing story to get to the investment story.”

Advance Asset Management’s Steve Gamerov observes that the MTM industry is a constantly evolving one, and that means you need to be looking at new strategies and new types of managers to enhance portfolio structures.

“Looking at the themes, there has been a shift to concentrated or high conviction managers — and that’s a global experience. Five or 10 years ago, there was a big focus on benchmarking and minimising tracking errors. This has come full circle and the focus is on removing constraints and allowing managers to deviate from benchmarks.

“Up to April this year, there were historically low levels of risk in equity markets and so portfolios risk levels had declined … also, the search for alpha has led many consultants and multi-managers to relax or remove constraints on managers. That’s one trend.”

The other big trend, he adds, is the move to alternatives, such as hedge funds, absolute return funds, private equity, infrastructure and long/short investing.

“Our experience is that there’s strong demand for multis, particularly from the smaller super funds, where the multi-blend funds represent a default option. Then there are the advisers who want to outsource investment research and portfolio activities.

“Some clients may use it as a core and satellite approach with say, a multi-blend fund as a core and then add extra aggressive strategies around that … but that’s getting more difficult because fund choice is expanding and time to research is more challenging in picking funds directly … switching funds is costly.”

Steve Hall, head of ipac Investment Services, says many multis seek out the latest, greatest boutique manager for their line up given that “there’s a lot of evidence to suggest that newer boutique managers have stronger returns in their formative period, but the corollary of that is more risk”.

“So you need to be cautious and put more effort into the due diligence process and appraisal of business efforts. And before these organisations become encumbered by their own success, the formative years (of these funds) are a good opportunity.”

Hall’s team of 45 at ipac has been busy working for various groups, including AXA, Tynan Mackenzie and Legg Mason, and more recently appointed CB Richard Ellis in global real estate securities. They were also the first manager to seed CB Richard Ellis and Boston-based boutique Arrow Street Boston with their small cap capability.

Other ipac sub-managers, where it says it has crafted innovative mandates with established managers, include Rosenberg in long/short Australian equities and Pimco, one of the world’s top fixed income managers, in a portable alpha strategy.

Says Hall about ipac’s new series of alternative balanced funds: “We’re also thinking about not only traditional MTMs, but about building portfolios which are customised to advice needs.”

Fee frenzy or fee fair?

One of the reservations that advisers and clients have had about MTM offers are the fees.

Given that there’s more layers involved, you’d think these would be fee heavy. But the promoters say they’re comparable.

Chris Condon says MLC has created a suite of products that doesn’t have trails and, he says, this makes them suitable for a clean comparison.

“It’s not the investment fees which are the major part of the cost chain; it’s the admin, the compliance, the regulatory oversight and the call centres. It’s also paying for advice.”

Wealth Partner’s Andrew Heaven says if you run a ruler through competitor management expense ratios (MERs) the MTMs stack up.

For example, Heaven says MLC’s Future Directions hedged international fund has a MER of 2.3 per cent, while sector specific funds such as Dresner are at 2.45 per cent, and AMP at 2.25 per cent. Barclays is 2.5 per cent on the international side.

On bonds, Wellington International MER is at 2 per cent, Future Directions is 1.9 per cent and AMP at 1.75 per cent, so (the rates fall) mid market. These rates apply to the AMP Flexible Lifetime Investment Trust, so other master trusts and wraps may have different MERs.

Julian Battistella, senior financial planner at Wilson HTM, says these days larger MTMs, such as Russells and MLC, have such massive FUMs that the fees negotiated with the sub-managers “are so sharp that they are no greater than a single manager”.

“And if I had to pay an extra 0.5 per cent I wouldn’t go down that path,” he adds.

“Recently, I switched from single managers to MLC and paid 0.01 per cent difference in MER of having four wholesale managers. Only one client had a large CGT [capital gains tax] issue, so we decided to wait it out until they’re in pension mode.”

However, Steve Gamerov says fee watching isn’t always in the investor’s best interest.

“Yes, there’s a push to reduce fees but … very often, those delivering better returns are the high alpha managers, who are limiting their capacity and, as a result, charging higher fees. So we see bottom-up pressure on higher fees, and what that means is multis will make less money or investors will pay out more to get higher alpha. Performance-based fees are one answer.”

Engineering the hope out of investing

Whatever you think, MTMs are getting great inflows and are definitely one of the fastest growing categories.

As MLC’s Chris Condon says: “MTMs engineer the hope out of investing … compared to a universe of 100 single managers with a wide dispersion of performance, a MTM approach will rarely be, on a year-by-year basis, in a top or bottom quartile.

“Of course, individual single managers will oscillate between both, and this is where investing in single managers can be problematic. Last year’s good performers may well be next year’s bad performers, but the MTMs will tend to be more consistent.

“But the MTM must have skill. It’s one thing to engineer hope out of a portfolio but the raw material — that is, the underlying managers — must be exceptional.”

The other aspect, Condon says, is: “When markets come off, then high convictions will be less affected, but when markets are going strongly, then they won’t outperform as much as benchmark-aware managers.”

However, capacity can dent performance.

“Capacity is an issue in the local market and increasingly we try to get involved with boutiques at an earlier stage of their development, when they have smaller FUM,” Gamerov says.

“What you tend to find is that good performance is likely in the early years. So size is definitely an issue in not having too many managers and not over-diversifying risk, and then giving just benchmark performance and over-charging fees.”

Optimix’s Emmanuel Calligeris says multis have a duty to deliver what they’ve set out to, and the hurdle is sufficiently higher to balance off good returns with an acceptance of risk.

He says many of his managers had a really good year, including: Alliance Capital; Capital International and MFS in international shares; Orion, BGI, ING in Australian shares; and Credit Suisse and Legg Mason in fixed income.

“We’ve been trying to determine the capacity that managers can accept and manage; it’s hard to know in such a growing market. If you have a look back, the markets were expanding fast … managers are best placed to determine their capacity mark themselves.

“What worries us is when they overstep. You need a system to gauge how far they can go to sustain performance.”

This year, Optimix replaced Investors Mutual and Schroder with Ausbil and Tyndall to get a better fit and ensure that managers complement each other.

“Blending is the hardest part of the multi-managers. Being a good portfolio manager … it’s science and art. Beauty is in the eye of the beholder.”

Sector versus multi asset?

Condon says one of the problems of the sector funds is that when you rebalance over time, the hardest thing is to put money into a market that has recently fallen.Yet that discipline is required.

“Over time, it’s a highly successful thing to do — buying low and selling high.

“So investing in a multi-asset fund is an excellent strategy … and many advisers have recognised this.”

Battistella says that while he predominantly uses direct assets and listed securities for his clients, the one exception is international shares.

“I use wholesale managed funds and given the choice of single manager versus multi-manager global share fund, I go for the latter for the reason that a large multi fund offers a more proactively managed solution and costs no more than a single manager due to economies of scale.

“With mature clients, I no longer use a single manager approach, as I find it unnecessarily cumbersome. This is because a Statement of Advice (SOA) is required every time you recommend a change of managers, and I don’t want my clients being in a position where I delay recommending a switch simply because we don’t have the time to prepare, send out and explain the SOA.

“Considering a multi-manager will proactively review and replace managers at any time, I can’t see the value in me trying to reinvent the wheel,” he says.

“Advisers are busy enough with strategy without preparing a SOA for a switch when a multi-manager can provide that benefit through their mandates. As well, you’re not crystallising the gain when a change of manager takes place. As a strategic planner, I’m happy to leave the process to the experts.”

Other boutique wealth planners like Centric believe it’s important to retain control over the manager line-up, particularly in a transition, and to be able to know what you’re getting.

Centric’s Robert Keavney says his group leans towards “boutiques [funds], which are smaller, less popular managers … usually MTMs aren’t offering those boutiques; they tend to go for larger names. It’s rare to find a multi with the range of funds we’re interested in.”

Keavney says he’s heard the same “little lectures” from the MTMs over the years about being better at research than financial planning firms.

“But my response is that some MTMs are good at research and some aren’t — just as the financial planning universe varies. We happen to think we’re good, so that argument doesn’t wash with us. But there’s lots of planners who’d agree with that position and prefer to delegate.”

Marcus Hanel, sector head for international and Australian equities at Standard and Poor’s, says the rise of multi funds is part of the shift away from advisers recommending product to strategy.

“If an adviser can spend more time on client relationships than picking the best next performing manager and then having to explain why one fund has underperformed, it frees up a lot of time.

“Mostly, advisers never track their switching or when they’ve underperformed the benchmark … but at the other end of the spectrum is the adviser who has great knowledge, and they can use MTMs as a tool.”

Hanel says MTMs give the automatic benefit of portfolio rebalancing at a low cost. This is particularly imperative for classes, such as Australian equities, which have had a great run.

“Rebalancing should be done when portfolios become skewed towards a particular asset, and not necessarily at regular intervals. Costs are associated with buying and selling, and this may not be necessary at the time of the client review.”