Sweet taste of multi-manager success

While most investments managers are currently standing at the door sadly waving goodbye to their carefully accumulated funds under management (FUM), one group of managers has to say farewell a little less often.

The multi-manager market has succeeded in holding onto its FUM far better than some of its industry counterparts, according to Lonsec’s latest report on the sector. Far from losing money, multi-managers have weathered the recent financial storm quite well.

As Lonsec’s Multi-Manager Sector Review 2008-09 noted, “Despite difficult market conditions, inflows across the sector remain positive, with multi-manager growth and balanced default options experiencing the largest flows”.

Although this is good news for multi-manager providers, it does raise crucial questions about these products.

What do they have that has allowed them to retain assets and even experience positive inflows?

While the secret is something many other investment managers wish they had at the moment, it is no great mystery, according to the experts. It is all about making the decision to head down the multi-manager route in the first place.

As Warren Chant, head of consulting firm Chant West, explains, once the decision is made, it is much harder to move than simply swapping managers in a single asset class.

Multi-manager funds — or implemented consulting, as it is called in the institutional market — are about both manager selection and an overlay of risk and portfolio management skills.

“To go to implemented consulting is a big decision and to change it is a big decision … To move means you are unhappy with the strategic advice and not just the performance,” Chant said.

Advance Asset Management’s head of investment solutions, Patrick Farrell, agrees the strategic advice included in multi-manager products is an important factor. “Multi-managers provide both portfolio construction skills and an overlay of forecasting experience. We forecast performance and the level of risk and the characteristics that environment will provide.”

Chant believes this skill overlay helps explain the slower ebbing of FUM. “This accounts for the ‘stickiness’ of money in the multi-manager approach,” he said.

Deanne Fuller from Lonsec agrees FUM in this sector tends to stay put. “It is meant to be a ‘set and forget’ strategy, and one where there is little need to change.”

The asset inertia was highlighted in the Lonsec report, which pointed out that while the sector’s FUM contracted 12 per cent, this was largely due to negative performance.

“Client fund inflows continued into the sector, with the majority of managers observing the largest inflows into the default balanced and growth options. Fund flow was supported by … an increase in interest from investors towards this type of product, generally at the expense of the more exotic funds that were severely impacted by the global financial crisis,” the report noted.

Managing the risks

This highlights how, in a more risk-aware world, planners and clients are much keener on careful management of the risks involved in investing, which is an area in which multi-managers offer

their assistance.

“One of the underestimated benefits of the multi-manager structure is that it provides an extra layer of risk management,” Farrell said.

“It is not just looking at the volatility risks, but also the other risks, such as liquidity and manager risk. A good multi-manager will look at the consolidated portfolio risk.”

He believes this overlay of risk management is very appealing. “We provide a level of capital protection.”

There is also protection in the detailed knowledge multi-managers have about their managers and their investment strategies.

Farrell points to the risks hidden within some of the exotic products and frozen markets investors have experienced in recent times. “It was hard to understand the embedded risks in these products, but we understand the risks and avoid them. We look after those problems for advisers.”

With strategy and risk management the responsibility of the multi-manager, planners are free to spend their time servicing and educating clients, rather than trying to cope with rapidly changing investment markets.

“Multi-manager makes so much sense for financial planners, as they can concentrate on managing their clients,” Chant said.

He believes that, once planners are freed from the time-consuming task of hiring and firing managers, they are unlikely to encourage clients to move investments back into single-manager portfolios.

“When financial planners say they can add value by picking stocks and managers, you must question how they can do that and match the resources of [a company] like MLC,” Chant said.

“When you think about the risks financial planners are taking on, you wonder why they would do it when someone else can do the homework and they can free themselves up to do what they do best and service their clients.

“People are often worried about giving up control, but they are really only giving up the manager selection decision. All you are doing is not hiring and firing managers any more,” he said.

Making life easier

The chief investment officer of MLC’s multi-manager business, Chris Condon, agrees multi-managers are a tool for making the working environment of planners easier without compromising clients’ investment returns.

“We work to ensure clients have the best managers in the world. We are the client’s agent,” he said.

“Clients have less need to churn their portfolio of managers, as we change managers when it is important to do so. This is much more effective.”

The funds also create greater efficiency for planners when it comes to the tricky task of portfolio decision-making.

“The investment environment is a difficult environment to make decisions in, and a multi-manager strategy helps with that,” Condon said.

Fuller agrees the multi-manager strategy can leave advisers free to spend more time on client-facing activities, which is where they can add real value.

“A lot of advisers were hurt by 2008 and, at the same time, they were trying to reallocate portfolios and rebalance. So, for some, it is a lot easier to hand it to the experts and leave the rebalancing to them.”

The multi-manager structure also helps reduce implementation leakage — the so-called leakage or loss of return from failing to implement investment decisions or to shift managers quickly and efficiently, which can cost investors dearly if they are out of the market while they move investments between managers.

Although this is a major concern for institutional investors such as superannuation funds with billion-dollar portfolios, it is also a considerable issue for planners, as clients can be out of the market for several days while they wait for a redemption and organise acquiring units in a new fund. As Condon noted, “Implementation leakage is an even bigger issue in the retail market … as it is even more inefficient when it comes to moving money.”

Multi-managers claim their approach can provide significant savings, with Ipac estimating its multi-manager portfolio can reduce the cost of changing a securities manager by over 80 per cent compared to the traditional method.

Chant agrees it can offer valuable efficiencies. “The reason people go the implemented route is it is more efficient. It costs less and offers better diversification and, operationally, it is more efficient.”

Farrell believes investing efficiently is vital. “You need to be nimble when the market is moving quickly and with the multi-manager structure you can make the changes in managers and assets without affecting the underlying advisers.”

Smoothing out returns

While these factors are significant, another major element to think about in multi-managers’ ability to hold their FUM is often their biggest handicap in rapidly rising markets.

Multi-managers are never top performers when times are good and, for many planners, this can be a big turn-off, but when markets are falling, their steady performance looks much more appealing.

According to Farrell, it is about providing clients with a smoother ride. “At Advance, we are not looking to shoot the lights out, we are looking for consistency in returns. That is more important than outperformance.

“We are not looking to be a first quartile performer. We use first quartile managers, but we are not aiming for top performance,” he said.

Chant believes this characteristic is appealing to clients.

“To go the multi-manager route is to reduce the swings and roundabouts in performance, as you get a smoother return pattern. It is hard to go outside this performance pattern, as there is not a lot of difference between the top and bottom quartile in multi-manager performance,” he explained.

While single-manager funds usually outperform when times are good, the multi-manager approach cuts out the market highs — and the depths of the market lows.

“[Multi-manager] clients get grumpy rather than really disappointed, as the range of outcomes is narrower. The purpose of the multi-manager approach is to make it a smoother ride,” Chant said.

This reduction in return volatility is also very appealing for planners, as clients who do not experience the extremities of performance are more likely to stick to their long-term investment strategy.

Blending portfolios and styles

The multi-manager approach also suits the current market environment because it recognises every investment manager goes through periods when their process is out of favour.

By diversifying managers, the poorly performing ones are carried by the better performers. It also means it is unnecessary to bet on whether value or growth managers will be the next top performer.

“One of the multi-manager benefits is that sometimes value managers do best, other times it is the momentum managers … It highlights the importance of risk management and blending different management styles,” Farrell said.

Mercer chief investment officer Russell Clarke agrees the science behind mixing managers together avoids the need for planners to select the right investment style.

“One of the attractions of a multi-manager approach is that it removes the reliance on one particular style or approach to generate positive excess returns relative to the market,” he explained.

However, careful blending of managers to create a ‘style neutral’ performance is not easy.

“Good managers are often eclectic in their approach and are not style boxed. For managers, the important thing is picking good companies and not matching a ‘style label’,” Condon said.

At Mercer, the firm is looking for strong diversification and managers “that can adapt to whatever market environment asserts itself going forward”.

“Mercer conducts rigorous due diligence on its underlying managers rather than on individual stocks and sectors. This approach seeks to identify those managers in whom we have the highest conviction and then delegates to them the stock and sector positioning used in the fund,” Clarke said.

High conviction is a common thread running through the multi-manager space at the moment.

“We allow our managers to focus on the things that they have high conviction about,” Condon said.

“This leads to a well diversified approach with high-conviction investments and managers. And this, in turn, generates returns based on high-conviction ideas without the volatility that comes from single-managers. We achieve very good returns and returns that are well diversified and risk controlled.”

Checking on the managers

Monitoring the stock exposures and investment risks taken by managers is something few planners would have time to do on a regular basis, but it is a daily activity for multi-managers.

“We do daily monitoring,” Condon said. “We collect the holding of our investment managers every day and collate the records to allow us to see the outcomes of the decisions that the managers are making.”

The information is then used by MLC to measure the difference between the actual manager and index exposures to create an ‘active money measure’. “This measure allows us to see how different the portfolio is to the index.”

At Mercer, the firm uses individual mandate agreements to ensure there are specific investment parameters in place. These include the minimum and maximum number of stocks allowed in the portfolio, together with maximum stock and sector positions.

“These must be adhered to, to ensure that all remains consistent with the overall objectives of the fund,” Clarke said.

“The appointed managers then provide exposure to a range of unique styles and approaches that should result in

a well-diversified portfolio of stocks carrying a higher probability of delivering positive excess returns across a full

market cycle.”

All this monitoring helps overcome the problems that can occur if a manager experiences business issues.

From Farrell’s perspective, this is one of the key reasons multi-managers have remained popular, as they have not suffered when managers have frozen unit trust redemptions.

“Investors have kept full access to their money, as multi-manager funds don’t invest in the underlying unit trusts — it is mainly done through mandates,” he said.

“This means we have complete control of the money and we have retained total control of liquidity.”

This point was taken up in the Lonsec report, which stated: “The use of mandates in a multi-manager structure is a far more desirable approach, as it facilitates tighter portfolio construction, better product design control, and the opportunity for better pricing and tax efficiency for investors and the efficient management of implementation and transitions.”

Given the state of the current environment, Farrell believes that this is important. “If a manager falls over, we have control of the assets.”

In an investment world where ‘back to basics’ is a high priority, the apparent simplicity of the multi-manager route is likely to see it remain appealing to many advisers and clients for at least a few more years.