Many advisers remain confused over multi-managers, so here is how to select the best of type fund or fund manager, position the fund to perform well in the expected market environment and control risk.
Having visited a number of advisers in the past few months it is clear they are struggling to differentiate between the various fund of fund and manager of manager (multi-manager) offerings, and desperately need help.
Moreover, like a tidal wave they are awash with more and more companies entering the multi-manager arena. This has led a number of advisers to conclude this is just the latest marketing fad from product providers, when in fact the multi-manager approach has been around for decades.
The reason it has come to the forefront now is three-fold:
The prolonged bear market made many advisers realise they were not as confident as they thought with investment management and so decided to outsource.
The bear market also meant advisers had to give their clients bad news for several years running. Now the value of specialist advice is valued much more, by clients and advisers alike.
The regulatory burden looks set to increase in the near future, with the FSA talking of introducing investment focused exams for anyone wanting to carry out investment business. This has led many advisers to limit their investment responsibilities by outsourcing.
If you are an adviser who has decided to outsource the asset allocation or the fund selection decisions, or both, to multi-managers, then this article aims to provide you with the right questions to distinguish between: the fashion followers - providers who are entering the market with little or no real track record or expertise - and providers who truly believe in the concept of managing money using a multi-manager approach and who have a demonstrable track record of doing it well.
I think it is unacceptable to adopt the view that, as all multi-managers pick the best managers for funds, why bother to research which one to use? No doubt they all arrive at very similar answers.
To my mind this is a very dangerous conclusion that can only lead to disappointment.
As the concept of multi-management is the same for every company, namely identifying and outsourcing the investment management to a range of fund managers for funds, how do you differentiate between good providers and the not so good?
The only way to discover if they walk the talk is to ask questions to determine the strength and weaknesses of the multi-managers. From my experience the questions to ask should revolve around the core functions of a multi-manager as well assessing any risks inherent in their organisational structure. If they can answer these questions satisfactorily it will give you confidence in their ability to perform well in the future and therefore meet your clients and your own expectations going forward.
We can define the core functions of multi-managers as: selecting the best of type fund or fund manager; positioning the fund to perform well in the expected future market environment; and controlling portfolio risk. So let's consider each of these in turn to see how we can challenge multi-managers. The following questions should be asked on how they select the best funds and fund managers:
• Can you explain the investment process behind how funds or fund managers are selected?
• How do you ensure the selection approach is applied consistently? Is it based on a documented well-defined process?
• Do you use a combination of qualitative, quantitative and technical analysis in your selection? If not, why not?
• Is your universe of funds restricted (fettered) or not restricted (unfettered)?
• Do you outsource all or any part of your research, or do you do your own proprietary in-house research?
• If you use external research is it paid for or bundled through a process known as soft commissions? (The latter could suggest bias in their fund selection process).
The following questions should be asked on how the multi-manager positions the fund to perform in unexpected markets.
• What are your investment beliefs behind how you invest and how are these put into practice?
• What investment approach do you use - beat a benchmark or focus on absolute return?
• Is this approach well documented and based on sound investment theory?
• What is your process in forecasting future market environments and how do they position the portfolio accordingly?
• With regard to fund of funds, will you trade in and out of the underlying funds frequently? (If yes, one can expect high turnover and hence incur high charges which are not disclosed but can have a negative impact on performance).
• How do you arrive at strategic and tactical asset allocation decisions?
• Why is the fund split the way it is? What is each part (manager and fund) achieving towards the whole portfolio?
• Does the portfolio construction process add value beyond fund selection?
Questions to ask on controlling portfolio risk:
• How do you identify risk
• How do you monitor risk
• How do you manage risk?
Questions to ask on whether the multi-manager's own organisational structure has any inherent risk:
• Is there a dedicated team who run your operations or are you a star fund manager?
• (If they are a star fund manager) What continuity plans are in place to cover periods of absence/sudden departures?
• Are you prepared to provide an organagram of the company and/or team in which the fund manager operates, coupled with details of the reporting structure in the team and how the team works together in practice?
• How long has the team worked together and what is its experience?
• Have you got a demonstrable and consistent track record of successfully managing money on a multi-manager approach?
• Are you big enough to negotiate discounts on the costs of running the money, in other words, no initial charge?
• (If they are a fund of funds) Are you big enough to ensure a low annual management charge?
• Are you big enough to get direct access to the fund managers or do you have to deal with a fund analyst or relationship manager instead?
• Is the multi-manager way of running money core to your investment approach and hence backed with resources focused mainly at that activity?
• Who owns you and what are the risks deriving from this?
• What is the TER of the fund?
I have tried to give advisers a few key questions to enable them to distinguish the quality multi-managers from the rest. At the end of the day when you outsource the investment management to a multi-manager you are saying to your client you have confidence in that multi-manager's ability to meet their expectations in respect of future investment returns. Can you demonstrate to your client why you have confidence that they should perform well?
• Multi-managers should select the best type of fund or fund manager.
Position the fund to perform well in the future.
Control portfolio risk.