Taking a fresh look at multi-manager funds

Multi-manager funds might have done well on the inflows front, but the dispersion between returns across the sector has been at its widest for a number of years.

This could be a direct result of some but not all multi-managers taking a fresh approach to investing, writes Janine Mace.

In an industry where the old investment certainties are no longer looking quite so certain, many product manufacturers are taking a fresh look at their wares, and multi-managers are no different.

With investors stubbornly refusing to re-enter investment markets in great numbers and conventional investment approaches under attack, many multi-managers are responding with new investment strategies and approaches.

It’s out with strategic asset allocation (SAA) and growth/defensive labels for assets and in with flexibility and dynamic responses.

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All this bending and reshaping means the traditional view of pre-packaged multi-manager funds being based around selecting the best managers across and within asset classes is no longer an accurate one.

As a result, Scott Fletcher, head of strategic wealth solutions at Russell Investments, believes many investors and financial advisers have the wrong idea about this increasingly broad universe.

“There is an outdated view of what multi-management is. You can’t throw a blanket over all of them anymore,” he says.

“People disputing the multi-manager approach need to reconsider what a multi-manager is now, as there are many types.”

These changes were highlighted in Lonsec's recent Multi-Asset Class Sector Review, which now groups diversified, multi-manager, multi-asset real return and multi-asset income funds together. 

Fletcher believes financial advisers need to take a close look at the approach being taken by individual multi-managers in light of new thinking about asset allocation.

“We draw a clear distinction between traditional multi-managers and the newer multi-asset approaches. The crisis showed who is still stuck in the 1980s-90s approach and who has moved on and embraced new investment approaches,” he says.

Right time, right product?

In fact, many multi-asset multi-managers believe their product is the right one for the current uncertain investment market conditions.

Stephen Roberts, Asia-Pacific regional business leader in Mercer's investment management practice, believes the environment makes the multi-asset multi-manager concept even more appealing – particularly given that most manufacturers offer a range of multi-manager options stretching from capital stable to high growth.

“This genre is increasingly applicable today due to the changes in market conditions,” he says.

“The sorts of things [assets] that are coming online are lending themselves more to the multi-manager approach. Single manager portfolios returns have been very bifurcated.”

Sam Hallinan, MLC Investment Management’s general manager product, agrees the revamped multi-manager approach suits the times.

“Since the GFC, the argument has shifted back to risk and this is a bread and butter issue for multi-managers,” he explains.

In light of this, Hallinan believes investors and financial advisers are increasingly embracing multi-manager funds.

“The market share of multi-managers has been growing over the last five to 10 years and is continuing to grow.” 

Multi-manager funds clearly are popular – particularly in the institutional market. 

“The bulk of the super industry is invested this way,” explains Warren Chant, director of consulting firm Chant West.

“Multi-manager is here to stay. Nothing has changed in recent years to say it is not continuing to be seen as the superior approach.”

The latest Plan For Life data shows multi-managers have done comparatively well in recent years. They have at least seen inflows – something many other sectors of the retail market would kill for.

At the end of December 2011, Plan For Life data showed retail funds under management (FUM) in the multi-manager space totalled $121.7 billion, which is almost level with the sector’s pre-GFC peak of $121.9 billion in September 2007. 

However, the December figures were down from their $127.1 billion level in March 2011, and inflows in the quarter were only $5.9 billion – which is around the same level as through the worst of the GFC in 2008. 

According to Lonsec’s Sector Review, most of the flows into multi-manager products are coming from other styles of multi-asset fund – particularly diversified funds, which are losing ground to their larger cousins.

“Multi-managers on the other hand, have noted a steady increase in FUM including Advance, Optimix, Colonial First State and Russell. IOOF (previously United Funds Management) has recorded a significant uptick in FUM following the merger of the United and IOOF Fund ranges. AXA/iPac have recorded declines in FUM on corporate uncertainty following the merger with AMP Capital,” the report noted.

Disappointment and investor sentiment

Despite the continuing inflows, most multi-managers believe ongoing market volatility has had a significant impact on investor sentiment towards their actively managed products.

Some investors felt let down in the aftermath of the GFC, explains Lonsec senior investment analyst, Deanne Fuller. 

“Many traditional multi-asset class funds disappointed during and after the GFC. They experienced significant drawdowns brought about by being structurally required to hold as much as 70% in equities,” she explains.

Fletcher acknowledges this was an issue.

“We saw some disappointment with the broad multi-manager universe after the GFC as returns fell more than people thought they might. This led to a reappraisal.” 

Multi-managers argue strongly their performance should not be judged on short-term, post-crisis results.

“With multi-managers, it is wrong to consider one to two-year performance. Multi-managers are not designed to be first quartile on short-term performance. They are about no surprises and no stuff-ups – they provide risk controlled exposure to the market,” Fletcher argues.

“Multis need to be judged on their performance in the medium to long-term. It is important to ask what they are there to do in the portfolio. They are there to deliver stable long-term returns in the portfolio centre.”

Hallinan agrees: “Multi-managers always perform reasonably well – not in the first quartile or the bottom quartile either – that is where they should be.”

Investor concerns about cost have also had an impact.

“When the market declines, there is a shift in focus to questions around fees for active management and whether it is cheaper to do it through indexing, etc, so this leads to sentiment towards multi-managers declining. We have seen it decrease a little, but much of this is cyclical,” Fletcher says.

While more costly active management may be somewhat out of favour with investors, multi-managers reject the idea that passive investing is the solution.

“Post-crisis, you get a lot of dispersion in stock values and it becomes a market for stock-pickers. You see a market driven by fear and macro events – not underlying stock values,” Fletcher argues.

“There is a lot of evidence to show index options are setting up investors for medium to long-term disappointment.”

Multi-manager, multi-asset or what?

Despite the arguments in favour of a multi-asset multi-manager approach, not all fund managers are the same. 

“There is definitely a gap opening up between those still taking the traditional approach and those taking a whole-of-portfolio approach,” Fletcher says.

This so-called ‘whole-of-portfolio’ approach reflects another factor reshaping the multi-manager market, which is the ongoing debate surrounding asset allocation and the use of growth and defensive labels for assets. 

Since the GFC, there has been a much greater emphasis on asset allocation. As Dr Shane Oliver, AMP Capital’s head of investment strategy, explained in an investor note last year: “Conventional constraints around asset weights, the move to sector specialist models and/or the focus on picking managers has meant that there is too little focus on asset allocation in many cases.

"However, in a world of shorter and more extreme investment cycles, and more negative correlations between equities and bonds, asset allocation is becoming critically important.”

This is a well-accepted view in the institutional market.

“Every asset consultant sees that the majority of value-add comes from asset allocation,” Chant notes.

The renewed emphasis on asset allocation has resulted in changes to some multi-manager funds. Many are now broadening their asset allocation ranges and rebranding themselves as multi-asset funds.

Some are going further and embracing new outcomes-based or real return approaches, rather than emphasising traditional strategic asset allocation benchmarks. This group includes managers such as AMP, Schroder and Select.

According to Lonsec’s Fuller, diversified and multi-asset multi-manager funds have traditionally been managed with reference to a SAA framework with some tactical asset allocation (TAA) tilts.

Following the GFC, several managers such as Mercer, MLC and Russell have widened their asset allocation ranges to opt for a more dynamic approach to asset allocation.

“While SAA is typically long-term and TAA shorter-term, dynamic asset allocation (DAA) aims to take positions over the medium term when markets are extremely over or undervalued,” she explains.

“We see this approach to be particularly beneficial when used as a risk management tool used to protect on the downside when markets are extremely overvalued, rather than used to generate alpha from the process (market timing bets).”

Seeking out the best

According to Fletcher, the best multi-manager funds are now not just about the best managers, but about the best assets, strategies and portfolio construction. 

“The multi-asset approach is about looking at all the building blocks and toolkits you have to build the portfolio and selecting the most appropriate,” he explains.

Hallinan agrees: “With multi-managers, traditionally there has been a concentration on manager selection. This is part of the reason why we are not keen to use the multi-manager term or manager-of-managers, as it is too limiting.”

He argues asset allocation is a central task for multi-managers. “When all asset classes are rising, asset allocation is not as important, but since the GFC, portfolio construction has become an increasingly important skill.”

From this, the best portfolio can be created, Fletcher says. “It is no longer manager research just on the best active stock-picker – now it is about researching across all types of active and passive manager exposure. Manager research and bringing them together is at the heart of the investment approach.”

Roberts believes many multi-manager funds are now much more sophisticated in their approach.

“Before the GFC, for multi-strategy funds 80-85% of total return came from strategic asset allocation and 15-20% from the implementation of dynamic asset allocation. The GFC taught us the value of DAA and led us to value that better,” he says.

Chant agrees there has been some rethinking going on about the value of DAA, but emphasises the difficulty of doing it well.

“Three years ago the big asset consultants were of the view strategic tilts in the medium-term did not add value, but two years ago they changed their tune,” he notes.

“The big players went back to the drawing board and convinced themselves medium-term tilts can add value – but it is very hard to achieve.” 

Death of growth/defensive split

According to Hallinan, another big issue for both financial advisers and multi-managers is the breakdown of simple asset categorisations such as growth and defensive. 

“Growth and defensive labels are not necessarily helpful, and multi-managers need to be better at helping advisers to understand the component building blocks used in constructing our portfolios,” he explains.

“Portfolio construction has to be the core value proposition of any decent multi-manager. It is hard to do consistently, but for multi-managers this is the ultimate differentiator. This is where the value is added.”

Fletcher believes quality multi-managers are now taking a more thoughtful and complex approach to portfolio construction. 

“When we construct a portfolio it is about determining the level of risk you want to take – risk budgeting – and then working out where and how you want to spend that risk budget,” he explains.

The decisions are not as simple as active versus passive, Fletcher notes, but are about “where to invest actively and where passively that will give the best result, and then put that together in a portfolio that achieves the outcome you are seeking”.

He says multi-asset portfolios help manage the portfolio more tightly for desired outcomes.

The performance question

When it comes to results, the ongoing lurches occurring in many asset values have had a significant impact on multi-manager fund performance.

S&P Fund Services analyst, Michael Armitage, highlighted this point recently when releasing new S&P Fund ratings for the multi-asset sector.

“Fund performances over 12 months to December 2011 were mixed, depending upon a strategy’s equity market correlation. Strategies with more long equity market exposure exhibited positive performance in the fourth quarter of 2011 in line with general equity market performance.”

According to Lonsec, the dispersion in returns amongst multi-asset funds has been at its widest for a number of years, ranging from -6.9% (Maple-Brown Abott Diversified Investment Trust) to 3.9% (Schroder Real Return Fund).

Among multi-manager growth funds (61-80% growth assets), the average return over the 12 months to December 2011 was -3.5%, with the average for five years to that date only 1.3% pa – well below the cash rate return.

Hallinan agrees performance results have been dispersed. “The more active you are in manager selection and asset allocation has definitely equalled better performance,” he says.

The recurring declines in equity markets have made life very difficult.

“Performance has been very asset allocation specific. For example, it has been very difficult for equities based funds recently. It has been a tough time for active management generally,” Roberts notes.

“In most managers, we have seen a reduced reliance on core equity strategies and a shift to other assets such as alternatives or commodities.”

Hallinan agrees: “Alternatives have been very important in terms of returns. MLC has been a big user of alternatives for many years, especially private equity and other assets such as catastrophe bonds and private debt, and this has shown in our performance.”

According to Lonsec’s Sector Review, multi-manager funds have generally invested more in alternative assets than their diversified fund cousins, resulting in better performance.

Fletcher believes this allocation shift represents an important change. “Unlisted asset investments have been successful, and this raises questions about the role of alternatives in a portfolio. Alternatives did what they are supposed to do in a portfolio during the GFC – and we will see an increased role for them in the future.”

Facing the challenges

Like all managed funds, the major challenge for multi-manager funds at the moment is the lack of new FUM flows.

“It is difficult for investors to filter out the negative noise in the market and all managed funds providers are finding FUM difficult,” Hallinan admits. 

Roberts does not mince his words about the difficulties. “It is not unreasonable to say 2011 has been the worst year ever in terms of FUM flows all around the world,” he says.

“In Australia, there is also added uncertainty due to regulatory change, such as MySuper and Simple Super, etc.”

Fletcher agrees the going is tough, with investors becoming increasingly cautious. 

“Generally what we are seeing is where money is not being redeemed, it is being moved into the more conservative end of the fund market such as bonds, cash and more conservative growth funds,” he says.

“In the fourth quarter of 2011 and the first quarter of 2012, we saw a continuation of redemptions across the industry, with some being more than in the depths of the GFC.”

Despite the difficulties with fund flows, most multi-managers believe they are better placed than many single strategy or asset class managers.

“We invest across different styles and so are less likely to see investors ‘chop and change’. This is more likely to happen in the non-core parts of the portfolio,” Fletcher claims. 

Investor concern about costs represents another challenge for multi-managers in the immediate future, says Hallinan.

“The key risk is fee pressures and there is a risk – which will be exacerbated by MySuper – that investors will focus too much on headline costs, and this will lead to inferior results,” he cautions.

According to the Lonsec report, the average wholesale management fee paid by an investor in a multi-manager fund has remained relatively steady at 88 basis points over the past five years. “This is a good result for investors, with competitive pressures keeping costs down despite a general trend towards the inclusion of more ‘expensive’ diversifying assets such as alternatives.”

Hallinan also flags issues for multi-managers around the impact the current raft of regulatory change will have on advisers’ business models.

“In a post-FOFA world, advisers will be looking to retain margin, and so they may look at areas where they currently outsource – such as investment solutions. This may mean they look to insource that again to maintain their margins.”

He believes advisers considering insourcing their investment activities may find the task more difficult than they anticipate. 

“To do it well – and consistently well over time – requires significant resources, which is hard for advisers to do,” Hallinan says. 

“Our argument has always been advisers should be concentrating on their natural skills – which are relationship building – and not on investment management.”

Opportunities ahead

While acknowledging this risk, he believes FOFA-induced pressure on financial advisers to improve their efficiency and deepen client relationships may see some advisers decide to outsource their investment activities for the first time. 

“Some will definitely look to outsource, so it is two sides of the same coin,” Hallinan says.

Unsurprisingly, Fletcher agrees outsourcing can be sensible for many financial advisers. “With multi-managers, this is often the approach the adviser takes with clients. They are not looking for top quartile performance and they are advisers who recognise that investment skill is not their key skill.”

He believes the regulatory change sweeping the financial planning industry makes multi-management even more appropriate, and sees it as a valuable opportunity for financial advisers.

“With FOFA, there will be more interest in multi-managers as the more investment decisions you make as an adviser, the more resources are required and the more administrative and legal risk you take on, so there is less time to focus on a small business’s bottom line,” Fletcher argues.

“With the multi-manager approach, you don’t have to worry about which manager is hot. If an adviser recognises investing is not their core skill, then with multi-managers you can focus on what is – strategic advice and relationship skills.”

Roberts agrees regulatory risk is a consideration which may make the multi-manager approach appealing for many financial advisers.

“A single manager return profile can be enchanting, but it also represents a significant risk,” he says.

“For advisers, you have got to get the strategy right and also establish risk and return criteria. However, the nuanced difference between then implementing that – or using a multi-manager approach which automatically evolves and which includes DAA – is limited.”

Market participants believe there are also other promising prospects available to multi-managers.

“The biggest opportunity for multi-managers remains taking the sophistication of the portfolios we have and extending it to the high net worth market,” Hallinan says.

“There is incredible sophistication in our multi-manager portfolios, and we need to be able to connect that to high net worth clients – not just low balance clients.”

He believes most financial advisers have continued using multi-manager funds mainly with smaller clients as manufacturers have been poor at explaining to them what is happening in the underlying portfolio.

However, Hallinan says this is changing, and manufacturers are looking at new ways to make multi-manager funds more appealing to higher balance clients.

“We have done a lot of work to unbundle the sophisticated knowledge in our funds and repackage it for new markets such as the high net worth group,” he says. This involves using MLC’s private investment consulting skills as a bridge between its institutional asset consultant teams and high net worth clients to create more tailored portfolios for these clients.