Multi-manager funds: adjusting to the post-GFC status quo

The global financial crisis has resulted in a change in the way multi-manager funds operate. Benjamin Levy explains why many funds are struggling to adapt to the new reality – and what this means for the sector.

The behaviour of the market since the end of the GFC is changing the way multi-manager funds (MMFs) work. Gone are the days of standard ‘set-and-forget’ portfolios. Highs and lows in the market are now measured in months instead of years, and fund managers who can’t keep up will fall to swifter, more powerful rivals.

MMFs are scrambling to adjust to the new reality, reviewing every inch of their old asset allocation mix and introducing new and numbered strategies to ride short to medium-term market gains. 

Concerns about fees and increasing time restrictions are also driving financial planners into the arms of multi-managers, who are creating a new price war as they attempt to drive down costs and attract more customers.

Funds under management (FUM) are booming as a result, with billions of dollars pouring into the sector over the last year.

But are some short-term strategies such a safe bet? Some new approaches are being criticised by fund managers for being untested, or a cop-out.

And an all-consuming focus on lowering fees through indexing, fundamental approaches and swap agreements may be causing some advisers to lose out on the potential gains active management may achieve.

The new reality

Before the global financial crisis (GFC), bull markets ran for five to seven years, giving planners ample time to readjust their portfolios. Now, the difference between market lows and the height of a new bull run is barely 18 months, leaving clients’ portfolios dangerously overweight.

“The strategic asset allocation [SAA] mix – ‘set and forget’ – is really starting to lose appeal in the marketplace. We’re looking at shorter, sharper economic cycles, so having a manager who has more flexibility to move the portfolio is quite favourable,” says Standard and Poor’s (S&P) multi-sector head Andrew Yap. 

While multi-managers in every company recognise the quickening share market cycle, they are reacting to it in different ways. 

S&P has seen many fund managers take advantage of the new, evolved market cycles by introducing a tactical asset allocation (TAA) overlay, according to Yap.

“If you think we’re going to be moving to shorter, sharper economic cycles, the rationale for the tactical asset overlay is that you’ve got conviction in a particular call or a view on an asset class, or the best way in which to take exposure to an asset class. If that’s the case, then a tactical asset overlay gives you increased flexibility,” he says. 

TAA is also being used as a risk dampener for many fund managers, Yap says.

BT Financial Group’s Advance Asset Management is one of those fund managers that recently expanded and enhanced its TAA guidelines to take advantage of short-term strengths in the market.

“Tactical asset allocation is going to be absolutely paramount. Not just for capturing the opportunity set, but to also provide some capital downside management as well,” says Patrick Farrell, head of Advance Investment Solutions.

The other half of the company’s market strategy revolves around its alternatives asset allocation. 

Advance recently reviewed the sector, increasing its flexibility, introducing daily liquidity and more transparency to make it more capable of dealing with market tremors.

“The market volatility you’re going to get out of equities is going to continue. You still will get periods of strength, but they will be coupled with reasonable periods of correction as well. We have to be smart about how we actually do those sorts of things,” Farrell says.

IOOF went through a full SAA review with Russell Investments earlier this year. The changes were dramatic.

“We used to have a peer group asset allocation, which was an average of the peer group. We looked at it and thought that wasn’t appropriate, and decided we would get new optimal asset allocations, ranges, and benchmarks, and roll that out,” says IOOF chief investment officer Steve Merlicek.

IOOF and Russell also implemented ‘strategic tilting’ – a high-conviction approach to asset class timing – that will sit around the new asset allocation strategy. 

A medium term asset allocation, the strategy temporarily tilts portfolios away from a default SAA and aims to take advantage of extreme asset valuations in the market.

However, tilting works differently than TAA. In more normal market environments, strategic tilting would be based on a medium to long-term view, in contrast to the short-term view of TAA – but the shorter economic cycle that has evolved since the GFC has given strategic tilting a short time frame, mirroring a TAA strategy.

“That’s not to say that you’ve become tactical, it just means that swings in valuations have been that much compressed and you still can make strategic shifts on a shorter time frame,” Merlicek said.

IOOF is heavily invested in strategic tilting. An investment team meets monthly to review the strategy, while Merlicek has appointed former Russell senior investment consultant Stanley Yeo to focus on it. They also take input on the strategy from various other sources.

IOOF used the strategy last year to tilt away from domestic equities to overseas equities when the Australian share market was underperforming, and used it again when US Treasury bonds dropped to returns of about 2 per cent.

Farrell warned that the shorter economic cycle was being compounded by quick money flowing in and out of the market from domestic and overseas investors.

“The high-net-worth individuals and a lot of overseas pension plans and defined benefit schemes are looking for a quick buck. They’re not looking to really play the long-term investment cycle just at the moment, they’re actually looking to get invested a few opportunities, get 5 or 6 per cent returns and then get out again,” Farrell says.

Dynamic asset allocation (DAA) is also on the rise. While there are “less than a handful” using the strategy, the number of fund managers investigating it is rising, according to Yap.

Dynamic allocation is the next step of tactical allocation, giving the fund manager an unconstrained ability to increase exposure to a particular asset class.

Investment ranges at an asset class level with dynamic allocations could range from 0 to 100 per cent, while tactical allocations could only range from 20 to 60 per cent. 

But fund managers need to be careful, because DAA is not for the faint-hearted. Just as tactical allocation requires more skills than strategic allocation, dynamic allocation requires much more skill than tactical allocation. 

Getting the drift

Some fund managers who don’t have mandates for TAA overlays have decided to expand their investment bands (ie, drift) to 5 per cent, allowing them to ride out short-term rises in the economic cycle without readjusting their portfolios, Yap says.

It could help when it is difficult to rebalance a multi-manager portfolio because of liquidity or inefficient pricing, he adds.

“There’s a component of judgement in there, or subjective overlay. Expanding the allowable drift will let the market run, basically. If they think the markets are overvalued then they’ll pare it back, but if not, they’ll let it ride,” Yap says.

However, instituting such a tactic could easily backfire. Tellingly, Yap admits that some of the managers who have instituted drift don’t have the experience of using TAA overlays.

Farrell believes the conditions aren’t right for drift to work properly, because the markets are not guaranteed to keep rising.

“Drift really plays out when you have strong momentum in the market. If equity outperform other classes, that slowly builds up an overweight position to what you believe to be a strategic position. Now if you continue to let that run you just become more and more overweight.”

Fund managers can’t be quick enough in this market environment to change their asset allocation, and if the market becomes too optimistic, it will eventually correct itself and all the returns gathered by riding the market momentum will be lost.

While drift is a form of TAA, it’s also one in which the adviser or fund manager almost abrogates his responsibility to the portfolio. They don’t continuously think about the performance of the fund, but rather let the momentum do the hard work.

Yap also admits it is too early to tell what the effects of drift would be on returns because it is only just being implemented. It is clear that the jury is still out on this one.

The key to knowing what the market is going to do is finding out information. But the key to that is not so much about how much information you can gather but whether you have the systems to screen it appropriately, Farrell says.

“Little bits of information when you actually add them all together can really dictate some quite valuable trends that are starting to emerge, and actually dictate some key turning points that you can find in the market,” he says.

Demanding value for money

The current difficult market conditions are playing right into the hands of the MMFs.

“The cycle that we’re seeing at the moment is definitely a stock-pickers cycle. We’re seeing waves of massive beta rises, the market levels out and then it’s the active management turn.

"But you can’t time that, it’s impossible for advisers or for clients to time it, nor do we advocate that,” says Matthew Zschech, portfolio manager for Infocus Wealth subsidiary Alpha Fund Managers.

Alpha Fund Managers relies on a combination of risk-adjusted beta as well as active management to generate the returns in their SAA multi-manager portfolios.

But more importantly, because they don’t believe they can add value to beta, they don’t charge to add beta at all, lowering the cost of a portfolio model to between 57 and 87 basis points. Other multi-manager portfolios can cost up to 100 basis points, according to Zschech.

Interest from financial planners has been very strong as a result. 

“It gives them the opportunity to build portfolios almost based on a mobile phone type plan,” Zschech says. 

Price is a critical consideration when advisers are under pressure from their clients to lower costs, and they are in turn pressuring multi-manager funds to offer lower fees.

“Fees is a big issue, it’s an issue for everybody. People want to make sure that when they pay active fees they get alpha,” Merlicek says.

IOOF has its eye on a number of strategies that the industry is using to try lower costs for advisers.

Some advisers are trying to negotiate with multi-manager funds to lower the fees for alternatives, while others are relying more on passive managers or fundamental indexing.

Boutique fund managers are also offering fee breaks as a way of attracting investment, while swap agreements are also becoming popular as a replacement for exposure, Merlicek says.

“All those things are still happening and they’re a continuing story in this industry,” he adds.

The core-satellite approach, which has permeated portfolio construction in nearly every part of the industry, has made its presence felt here as well. 

Advance is following the trend closely among financial planners.

“Some advisers tend to use an index fund as a core. What we’re finding is that a lot more advisers nowadays are using our funds or a good diversified fund as a core, because we’ve been able to demonstrate that they get the delivery of performance,” Farrell says. 

However, chief executive of hedge fund firm Financial Risk Management (FRM), Richard Keary, warns that low fees are not the be-all-and-end-all of MMFs.

“Australia as a jurisdiction, more than any other jurisdiction in the world, uses fees as a discriminator. Rather than rank fund managers on net return, they get ranked on their management expense ratio [MER], and a high MER is anathema.”

FRM Sigma Fund combines several multi-managers to create a best-of-breed managed futures fund. 

Not everything that’s cheap is good, Keary warns.

This is a time when active management should pay for itself, whether it is expensive or not, he says. 

Time is of the essence

The other drawcard of MMFs for financial planners is the amount of hours they save, giving planners more time with clients instead of documents.

“If you look at their business models, [advisers] have to start to find a way to be more efficient. They can’t necessarily rely on being able to go out there and spend the necessary time that they used in terms of picking funds, and figuring out what sort of investment strategy that they have,” Farrell says.

Incorporating TAA within Advance’s multi-manager funds also means that advisers don’t have to rewrite Statements of Advice to take advantage of market volatility, Farrell says.

“It includes a lot of business efficiency, and we’re finding that advisers love it for that fact,” he adds.

The added fiduciary responsibility that will be added on to financial planning requirements when the Future of Financial Advice reforms are introduced will mean advisers will also be under pressure to show clients how much time and effort they are putting into their investment strategies.

Farrell believes that is a big ask for planning practices that are continuing to face more pressured dynamics, and MMFs will benefit as a result.

Time, or lack of it, also becomes a much more important factor in a short economic cycle. Investors must be able to implement any portfolio changes very quickly and cleanly without losing any possible performance returns.

That is beyond the ability of most advisers, and, together with the quality of investments, it plays a big role in the growing attraction of MMFs.

Efficient implementation is a benefit that is not given proper recognition by the market, according to general manager for MLC Investment Solutions Sam Hallinan.

Using a multi-manager fund offers near instant implementation of a decision to rebalance a portfolio, when doing it yourself can take many months, Hallinan says.

“Over time, it adds up in regards to portfolio performance,” he says.

The Australian dollar – which MLC believes is overvalued according to a medium term outlook – is a good example of why advisers should rely on multi-manager funds to implement a portfolio change, Hallinan says.

“We want the ability to change our portfolio’s allocation to unhedged global equities as quickly as we can,” he says.

Letting a multi-manager do the rebalancing adds discipline to the process, and it is also more tax effective for the adviser, Hallinan says. 

Meeting with a client only twice a year while the market can move strongly up or down within that timeframe can have disastrous implications, Yap says. 

Ready, set, grow

The increased interest from advisers in MMFs is showing up in their inflows.

A Lonsec analysis of the sector late last year revealed that the multi-manager sector had grown by 23 per cent to $246 billion in FUM until August.

MLC saw an increase of 52 per cent in flows following its purchase of a Pre-Selection fund range, which boosted its FUM by $39 billion. Advance recorded 17 per cent growth, Mercer 14 per cent, and Colonial 13 per cent.

Advance has seen continual growth in its MMFs right through last three years, Farrell says.

“We’re getting returns 2 per cent above our benchmark. That kind of traction from a performance perspective obviously gains a lot of trust and respect from the financial planning community, and that’s where we’re starting to see a lot of flows starting to come in,” he says.

Inflows are also coming in because advisers are attracted to the way Advance delivers after-fee returns to investors, Farrell adds.

IOOF recently merged its wholesale funds, MultiMix portfolios and United Funds Management, and is in the process of merging the retail side of the funds, in an effort to optimise its manager structure.

IOOF has been trying to avoid the duplication of costs, get larger mandates and negotiate lower fees for members, as well as avoid mixed messages from the two platforms, Merlicek says.

The funds had a pleasing jump in performance as a result of the mergers, he says.

Part of the jump in performance was also due to the restructure of IOOF’s SAA with Mercer, Merlicek says.

However, despite the jump in performance, IOOF’s discretionary inflows are still suffering.

“There’s not a lot of flow into many multi-manager funds at the moment, because people all seem to be saving money. The savings rate is the highest in 20 years. A lot of people are paying off their mortgages, and there are changes to super as well. That’s across the industry.”

Discretionary flows haven’t picked up since the GFC, despite IOOF maintaining the size of their funds as well as compulsory super contributions, Merlicek says.

IOOF’s multi-manager portfolios were worth approximately $10 billion in February last year.

Alpha Fund Managers currently runs five asset-class based funds, blue chip, small cap companies, global opportunities, listed property, and enhanced yield.

Alpha has 14 managers across the five funds, including some big boutique names in the industry. Bennelong, Greencape Capital, Equity Trustees, Perennial Investments, QIC and Putnam are among the names. 

“Across any portfolio, we’ll only look at a reasonably concentrated manager line-up, and we differentiate those guys by strategy in the portfolio as well.

"We look at quantitative analysis, and the due diligence that we do there, and we also look at qualitative analysis, because the way that we construct our fund is quite different in that we follow a clear alpha-beta separation.” 

Alpha Funds have added approximately $190 million in funds under management in the last three years.

Only those multi-managers who are stable will continue to do well in the ratings and among investors, Lonsec warned the industry in its review.

Some companies exposed to corporate uncertainty, like AXA/ipac, which was up for sale at the time, only received a ‘recommended’ rating.

However, should the market continue to behave the way it is, most MMFs are guaranteed to be around for a long while.

“We advocate that advisers pursue very sensible strategic asset allocation in building portfolios. It’s definitely not a time to be betting the farm on any one strategy, that’s for sure,” Zschech says.