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Multi-talented

Written by Ilonka Oudenampsen
October 2011

Ilonka Oudenampsen explains the varying definitions of multi-management and the benefits it provides for investment diversification

After the financial crisis the need for diversification seems greater than ever, while restraints on trustees' time and expertise seem to tighten. One of the solutions available is multi-management, which has become more popular and varied in recent years.
The term multi-management often creates some confusion, as it can be understood as a less delegated form of fiduciary man-agement but also as the appointment of a manager offering a bundled package of assets, similar to hedge funds.

In the first instance, trustees appoint a multi-manager, who chooses different managers investing in a certain asset class. The difference with fiduciary management is that the latter also takes into account a pension fund's liabilities and focuses more on the funding ratio, whereas multi-managers focus on a single asset class.

FundQuest director Guy Davies says: "A multi-manager approach effectively delegates the selection and ongoing monitoring of underlying specialists to a specialist company. By including strategic and tactical management, the approach naturally extends to fiduciary management or it can display more absolute return characteristics."

According to head of clients at Cardano UK Richard Dowell, fiduciary management is still less popular in the UK than it is in the Netherlands, but is growing in popularity. "Fiduciary management is more holistic in nature, allocating across a range of asset classes and potentially also liability hedging instruments, whereas a multi-manager is generally focused on only one asset class. Trustees would appoint a multi-manager because they want to get access to a range of different managers instantly for a particular asset class, rather than wanting to delegate the whole fund to someone else."

When looking at multi-management as a manager offering a bundled fund, a pension scheme would invest in a fund which invests in different asset classes. The appointed multi-manager chooses the underlying assets in the fund and monitors their performance.

Man Multi-Management head of portfolio management Hans Hurschler says: "The downside deviations of hedge funds are quite a lot lower than equity markets and are also lower than bond markets. Hedge funds are not wizardry and are not helping every day, every week and every month, but over a very long term period, if you have a look at your asset allocation and blend them well into your asset allocation, they do exactly what you need within your asset allocation and are a big help in controlling volatility."

Alliance Bernstein head of blend strategies Patrick Rudden says that there are a lot of differences between these so-called diversified growth funds. "There are some which have a sort of semi-open architecture and some with a closed architecture. Some are absolute return, while others are capital preservation. To me investing in diversified growth funds is outsourcing-lite, the first step on the path to outsourcing."

And outsourcing is what it is all about. Whichever definition multi-management is given, in both cases trustees are able to diversify their portfolio without having to actively seek out, appoint and monitor a wide variety of managers.

Pension schemes can choose to delegate whatever elements they wish, or even all their decisions, to a third party while still retaining responsibility. Davies explains: "It depends on the time and expertise a pension scheme may possess. The important thing is that, when trustees are looking at who to delegate to or what they wish to delegate, they define their mandate clearly and thoroughly review the resource and breadth of experience of the professionals they are looking to delegate to."

Independence of investment decisions and transparency is also vital, according to Davies, but ultimately the trustees have to be comfortable that implementation can work, as some of these structures can be quite complicated.

Diversification and controlling the downside are vital for pension funds, according to Hurschler. He believes the right instruments and transparency can increase efficiency, and a 10-20 per cent allocation creates a more efficient portfolio with lower volatility and a higher return.

"In a pension fund it is extremely important that you don't have large drawdowns because of the compound effect. If you only have small drawdowns you can recover. You could also, if you're entering a difficult environment, perhaps on the equity side decide to take some beta out of your market and allocate some to hedge funds, because they protect you much better," he says.

Dowell adds: "Trustees who use multi-managers will need to look for skill: do they give an edge over what we're doing at the moment? It is also important for trustees to understand what fees they're paying and how they're paying these fees, but also what risks are being run within those structures and how they can control those risks versus other risks being run across a pension scheme."

This last point is the main disadvantage of multi-management, as trustees lose the ability to control risk as much as they used to. Dowell says: "Those decisions are being taken by the multi-managers and they tend to be thinking in isolation of their own particular asset class or their own portfolio and not in the wider context of the overall trustees portfolio."

However, Rudden believes there are very few risks involved with multi-management. "If you're a pension fund you've got to say: how do I best spend a limited governance budget? Some of them have the time and expertise to do this in-house. Many others will feel that the important thing is that they set the overall strategic risk budget and parameters, and they are very happy to outsource the implementation to someone with alleged expertise."

Over the years multi-management has gone through a meta-morphosis and has branched out a lot. Davies explains: "The term multi-manager 10 years ago really referred to plain-vanilla equity and bond funds employing more than one active investment manager. Now we're very much looking at combining our research with strategic and tactical management for a host of different types of clients, from fiduciary relationships through to absolute return strategies, in addition to the more plain-vanilla strategies we've managed for over 10 years."

Rudden says that in the UK multi-management is mainly used by (closed) defined benefit schemes, as the governance issue then becomes something of a legacy problem, which trustees are more willing to outsource. In defined contribution this trend is well underway as well, due to the growth of the target date fund, as the default option, which is essentially a multi-asset portfolio and usually multi-managed.

"Multi-management started in the Netherlands, where 94 per cent of the pension market is outsourced, and it's starting to happen in the UK as well. In the past we've seen stuff that starts in the Netherlands, gets adopted in the UK and then spreads to the US. I believe that within a decade most corporate plans in the UK will be outsourced and I think the trend will be well underway in the US."

Written by Ilonka Oudenampsen



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