Is it time to reconsider multi-manager funds?
Multi-manager funds deserve to be reconsidered by advisers and their clients, particularly because many managers have changed their approach to make the option more attractive, according to Tyndall’s Ken Ostergaard.
Over the last few years, the multi-manager approach has fallen out of favour.
While there are some good reasons for this, a number of multi-managers have now changed their approach in order to generate significantly better returns for investors, making it timely to reassess multi-manager funds as a way of adding diversification to a portfolio.
A multi-manager approach to investing is potentially one of the most successful ways of optimising risk-adjusted returns. At the same time, it is also one of the most challenging – and I believe needs specialist skills and active management.
There are two main prerequisites for a successful multi-manager:
- An asset class with sufficient diversification opportunities – eg, equities; and
- A rigorous and disciplined portfolio construction process that efficiently blends quantitative science with qualitative forecasting.
In the past, many multi-managers did not place enough emphasis on this second point, although it is now being given attention.
Investors should therefore reconsider multi-managers and assess them on new criteria, as they can provide a number of benefits in investor portfolios.
Manager blending
One of the main problems with multi-managers in the past was that, in many cases, the strategies they used to ‘blend’ managers simply resulted in a ‘bland’ outcome.
With most of these funds, the average number of underlying managers invested with was eight. Clearly, there was a problem in managing this number of managers in a way that generates out-performance.
By blending too many managers and stocks, some multi-managers ended up with a portfolio with characteristics similar to the index. And it’s impossible to beat the index by replicating it!
Instead of performance being largely a result of stock and asset allocation, it becomes merely a random function of so-called factor risks (small benchmark deviations to countries, sectors and currencies).
Historic performance
Another common mistake made by some multi-managers in the past is that they put too much emphasis on short-term past performance when selecting managers, rather than making decisions about future trends and opportunities and then allocating funds accordingly.
Such managers lined up what they believed were the best value, growth, small cap managers, and so on, based on their recent performance.
They then back-tested those managers’ returns and correlations over a relatively short period, and optimised allocations and allocated money based on this s hort-term historic performance.
As a result, allocations were static, and rebalancing back to strategic weights took place as if recent history would repeat itself indefinitely, with no dynamic asset allocation taking place.
On top of this, all of the excess return expectation was being outsourced to the underlying managers, implying that all alpha should come from stocks only, even though academic studies clearly suggest it comes from asset allocation, stock selection and currencies (in global equities) and not just from the one source.
The new generation
These limitations do not now have to just be accepted by multi-managers and therefore by investors.
If done properly, a multi-manager offering – by nature – should be a core/style neutral offering designed to perform consistently well in most market conditions, and with controlled risk levels.
When done correctly, a multi-manager approach can bring a number of benefits. These include:
- True diversity in management style and approach, and underlying stock selection;
- Active management of over- and under-weight positions;
- Identification of investment opportunities and the ability to move quickly to take advantage of them - for example, expanding allocation to emerging markets managers;
- A qualitative and quantitative overlay on manager selection that takes into account historic and future trends to identify and quantify returns in a relative sense; and
- The ability to manage market volatility and ride out the highs and lows over the short term.
Additional value can come from having a framework in place to actively manage volatility and other risks (and opportunities) normally not expected to be done by the underlying managers, such as dynamic asset allocation.
As an illustration of how multi-managers have changed in recent years, at Tyndall we recognised the potential short-comings of the multi-manager approach a few years ago and took steps to re-assess our approach and ultimately relaunch our two funds.
One of our key decisions was to do without an external consultant and instead build a new internal team.
Over time, we expect only about 50 to 60 percent of our alpha to come from stock selection.
All asset allocation (strategic, dynamic and tactical) is retained in-house, and we anticipate 40 to 50 per cent of excess returns will come from here over the long-term.
For example, in our world equities funds, our strategic approach identified emerging markets some time ago as a key long-term investment theme, with expectations that they will outperform developed markets by an average factor of three-to-one over time.
We then selected the best emerging markets manager that met our criteria, as well as developed markets managers who were not allowed to hold emerging markets stocks. This approach allows us to actively manage the emerging vs developed markets play.
When it comes to blending and selecting managers, we believe in a philosophy of “less is more”: ie, fewer rather than more managers. We have five managers in world equities and only four in Australian equities, or about half of the industry standard.
The result is that we have very different managers whose correlations to one another are analysed in detail over different time horizons and in different market environments.
At Tyndall, we have segregated mandates with all our managers (as opposed to investing in unit trusts), which has the benefit of us dictating how we want our portfolios to look rather than buying “off the shelf”.
It also means we get up-to-date stock portfolios on a daily basis which we feed into our proprietary exposure reports, so we have constant up-to-date portfolio exposures. This enables us to make informed investment decisions daily (rather than monthly or quarterly).
We also use an array of financial instruments, particularly ETFs (exchange traded funds), to manage sector exposures on a short-term basis in order to smooth returns to ensure out-performance year-in and year-out.
This kind of multi-manager approach is very different to the approaches taken in the past - and it has significant benefits for investors and their portfolios.
Ken Ostergaard is head of multi-manager funds at Tyndall AM.
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