The Australian financial services industry has undergone dramatic change since the Federal Government’s deregulation initiatives in the early 1980s.
Of the many evolutionary developments, one that stands out is the growth in the number of multi-manager portfolio providers.
In June 1991, there were just six multi-manager providers. At the end of 2007, there were nearly 40.
While a broader choice of multi-managers for financial planners is a good thing, it also complicates the selection process they face.
However, one way this can be simplified is by distinguishing between multi-managers who do their own manager research and those who rely on manager research (and hire/fire recommendations) provided by external research providers.
The decision by some multi-manager providers to outsource the manager research function is not without issue and planners should be aware of this when making their choice on behalf of clients.
Because the creation, construction and ongoing management of a multi-manager strategy is a formidable task, many financial institutions entering the multi-manager arena have chosen to outsource the manager research function to external research providers or consultants, rather than establishing their own research capability.
This is especially the case for institutions where multi-manager investing is not a core business and the decision to offer multi-manager products is driven more by business development considerations rather than a deep philosophical belief in multi-manager investing.
This is in contrast to a number of investment firms that, because multi-management is all they do, have built their own manager research capability.
The decision by many multi-manager providers to outsource manager research responsibility has clearly been beneficial for numerous consultants and research houses.
These firms typically offer a wide range of services to their clients, not just manager research.
The problem is that these multiple services are undertaken for multiple clients.
Each client presents the consultant with a unique set of challenges because they have specific needs, preferences and requirements through time.
Depending on how well the research provider has resourced their business, providing tailored solutions that meet individual multi-manager needs could be challenging.
Contrast this with a multi-manager provider which has its own manager research team.
Having an in-house research team that is devoted exclusively to servicing a single client (i.e, the firm’s own multi-manager strategy) means the team has a far greater awareness of what research needs to be done and can tailor their research accordingly, without the distraction of multiple clients with competing needs and demands.
As a result, an in-house research model is more likely to be able to make recommendations on manager strategies that are truly aligned with and tailored specifically for the multi-manager’s portfolios.
Another consideration for planners choosing between multi-managers is the breadth and depth of the manager research that is done.
Research providers are in the business of selling research, so they often promote the fact that they maintain the opinions of many managers by conducting hundreds or thousands of manager reviews annually.
Rather than focusing on the absolute number of manager research visits, planners should be asking about the relevance of those reviews to the end multi-manager product.
In such a broad research agenda, there is a good chance that the research provider is covering managers with inferior investment credentials.
This represents a waste of valuable and scarce research resources that would be better devoted to monitoring incumbent managers and others worthy of detailed research coverage.
Because an in-house research team working on behalf of one client doesn’t have the pressure to be ‘all things to all people’, research can be directed to where it is most relevant for the multi-manager strategy that they are directly responsible for.
Distractions such as reviewing managers who lack the necessary skills are minimised, thereby freeing the in-house research team to focus only on incumbent and ‘high-interest’ managers.
Another issue planners should be aware of is the need for external research providers to ensure they communicate manager recommendations in a way that doesn’t advantage one client over others.
To achieve equality, a recommendation should be sent to all clients at the same time. More often than not, research providers also communicate their manager recommendations to the broader market; publicity is good for business.
While it is important to treat all clients equally, it does create challenges for the recipients of the recommendation when implementing the recommended manager change.
For instance, if the research provider recommends terminating a manager, it is likely that all of their clients who use that manager will be heading for the exit door at the same time, and this could result in implementation difficulties that compromise client return outcomes.
This isn’t an issue for multi-managers that base their manager selection on their own research, because their business model does not entail selling their research and recommendations to external clients or the broad market.
As a result, they are in a far stronger position to make manager panel changes in a cost and tax-effective manner, without the glare of market-wide publicity.
One final issue that can have a direct impact on clients’ returns relates to the treatment of underperforming managers.
If an external research provider has a short-term focus in its assessment of manager performance, or there is pressure to be seen to be doing something for clients in response to underperformance, they may pull the trigger too early.
By doing so, the underperformance is realised and clients are denied the opportunity to make up the performance shortfall when the manager’s style is back in favour and returns improve.
The in-house research team does not face the same pressure to ‘do something’ if a manager underperforms.
As long as the manager retains its competitive edge and the original reasoning behind the manager’s appointment is intact, an in-house research team won’t face the same pressure to pull the trigger in response to short-term underperformance.
The choice of multi-manager strategies is expanding as more and more financial institutions want to participate in this growing segment of the financial market.
But the selection process can be simplified if financial planners focus on the way each multi-manager provider generates insights on managers. Do they do it themselves or have they farmed out responsibility?
To inhouse or outsource, that is the question.
John Owen is a research analyst at MLC Investment Management.
