Multi-manager – pensions panacaea or pain in the neck?

Multi-manager funds would seem to be the panacea for people without the inclination or time to invest in stock markets. The trend in the retail funds market suggests that private investors have cottoned on to their supposed benefits. Data from Lipper FERI suggests that demand for multi-manager funds is strong. UK-domiciled funds of funds have grown at a compound annual growth rate of 29.4 per cent from the beginning of 2004 to the end of 2007.

If it works for private investors then you could argue that it should work in the corporate pensions market for many of the same reasons. They should be able to help trustees avoid making their own asset allocation calls. A multi-manager approach should also alleviate any of the worries employees in contract-based schemes have because asset allocation calls are being made on their behalf without having to worry about switching funds. They are the perfect default fund, so to speak.

That is certainly how the multi-managers position themselves – with trustees their main target market. Trustees are responsible for the ongoing monitoring of funds and for dealing with underperforming managers as they deem fit. This puts them under immense pressure. Many are simply volunteers from the shop floor who lack the required investment knowledge and/or the time and resources to successfully choose and adequately monitor their investment managers.

In a multi-manager arrangement, the trustee appoints a single entity to hire and fire the investment managers. Ashish Kapur, European head of solutions at SEI, a leading multi-manager, says: “We reduce the complexity of choice – rather than trying to pick from three or four UK funds, they can have a single fund with a range of managers running the portfolio – we do the hiring and firing on their behalf.”

The advocates of the multi-manager proposition reckon the current market mayhem will aid their cause. David Millen, director of client services at multi-manager Russell, says multi-managers are better able to control risk: “The chickens have come home to roost because schemes have been relying heavily on equities.” He adds that corporate sponsors are wondering how they can wash their hands of the problem, and multi-manager can be the answer.

Michelle Cracknell, strategy director at Skandia, wonders how many trustees understand the difference between manager of managers (MoM) and fund of funds (FoF). “Most trustees and certainly members don’t know the difference. I think trustees probably decide between the two, based on whichever concept has been sold the best. They both have their advantages and, of course, it is possible to use both.”

What appears to be the case is that the MoM providers are proactively bidding to win business in the corporate pension workplace. The FoF brigade, that are more popular on the high street with private investors, do not appear to be too bothered whether they are used or not by trustees. They will pick up business on GPP platforms such as external fund links offered by the likes of Standard Life, Scottish Equitable and Skandia.

Tony Lanning, head of multi-manager at Gartmore, says that its funds are few and far between in the DC space: “We see multi-manager as a very good risk based solution in the Self Administered Pensions arena. For example, in Sipp and Ssas for clients who want to devolve asset allocation and fund selection to a professional.”

As more trust-based schemes disappear, funds of funds could become the preferred multi-manager option of choice – and as it stands the popular funds include the top sellers in the retail space from Jupiter and New Star.

Graham Dow, head of global fund relations at Standard Life, says: “What I am seeing, particularly with a move away from a trust-based environment to a contract one, is a greater focus on funds which offer risk controls rather than a focus on producing pure alpha.”

Cost and performance continue to be the hot subjects when talk of multi-manager funds is discussed.

Multi-managers, perhaps more than traditional fund managers, are judged on performance because you are paying extra for their expertise. It is a difficult area to monitor – particularly managers of managers. What results can be gleamed are far from conclusive.

Take a look at the balanced and cautious managed sectors over the past three years and Morningstar figures do not show multi-managers in a favourable light. Two in three fail to deliver above average performance – and some of this underperformance could simply be down to the impact of higher charges. A look at multimanager funds offered by Skandia in the personal pension place show that external funds linked to Credit Suisse, Fidelity, Gartmore and Schroders multimanager propositions, have underperformed the average over the past 12 months by half, according to Morningstar.

Lee Smythe, an analyst at Killik, the stockbroker, says: “A quick glance over the performance tables tends to show most funds with either manager of managers or fund of funds as having performance which is either 3rd or 4th quartile in their sectors.

“This could in part be explained by the higher charges which apply to these funds, sometimes 2.5 per cent per annum or more, total expense ratios (TER), but I suspect is also in part due to the slightly disjointed effect you get when compared to a fund where all of the money is actually invested by one team.”

He adds: “Another slightly contentious issue would be the manager’s use of their own company’s funds in the portfolio, which may be held for political rather than performance reasons.”

Russell and SEI admit that some funds outperform and others don’t. For example, a look at the CAPS Pooled Survey shows that its UK Balanced Fund is fourth quartile. Herein lies a difficulty for multi-managers. They should be, by definition, a perfect choice for a default option – but cost is a barrier and unless they deliver, the expense is an easy argument for critics to throw at their multi-manager offerings.

The major criticism with fund of funds is that they are expensive in comparison with conventional funds because of the double layer of charges – one levied by the underlying investments, the other for managing the fund. The cost is a major reason why funds of funds have struggled to make as big an impact as manager of managers.

A Jupiter spokeswoman says: “The Jupiter Merlin funds populate many Sipps from leading providers such as Standard Life and Hargreaves Lansdown. But for GPP and other DC schemes the cost limitations usually preclude the inclusion of multi-manager funds. Most company schemes operate within a 1 per cent charge cap, which needs to include scheme and fund costs, so again that would preclude Jupiter Merlin funds.”

In fact,TERs have been falling, but they are still higher than most traditional funds. According to Lipper’s research into the annual charges for 138 multimanager funds from 24 companies, TERs have been falling, more obviously for external funds of funds where there is more scope for different fee negotiations.

But managers of managers are still far cheaper having fallen from an average of 1.91 per cent in 2005 to 1.84 per cent. On the other hand, funds of funds average 2.34 per cent compared to 2.51 in 2005.

Ed Moisson, director of fiduciary operations at Lipper, says: “Traditionally the most effective means to keep annual charges under control in a multimanager product is to take the manager of managers’ route, rather than that of a fund of funds. The outsourcing of fund management via mandates, rather than the selection of underlying funds, aims to end the layering of annual charges that ultimately impacts on investors’ returns.

There is also a view that people are put off multimanager funds because they are nervous. Richard Wallis, head of research at Origen, says: “Members are reluctant to commit money to some of these funds – they still look at lifestyling and trackers.”

Some multi-managers argue that passive funds are ‘a cop out’ during times of uncertainty – it’s why many trustees and contract-based schemes stick to an index offering for their defaults. This is particularly true where the scheme has suffered from poor performance from active funds in the past, and the legacy has stuck.

Kapur says that he does not believe that cost is such a burning issue, and questions the double layer of charging argument that tends to be thrown at multi-managers.

“The double layer does really tally – we can pool assets, which gives us more buying power and economies of scale that is crucial in DC. Decisions are driven by fear. Trustees and individuals tend to be poor at selection, looking at past performance rather than the level of risk – and so they opt for passive in the hope it will save their own backsides.”

But Andy Cheseldine a senior consultant Hewitts Consultants, disagrees with the notion that choice has nothing to do with charges. He questions whether multimanagers do actually add value. “The problem with multi-managers, even managers of managers, is that they are taking profits – even if they offer discounts on charges to companies.” he says.

The cost issue will continue to linger (although the increased use of exchange traded funds in some portfolios will help reduce costs even further) and it will be a huge barrier to multi-managers making headway in 2012 with Personal Accounts. The 30bsp charge will be impossible to meet, say the multi-managers.

Where they may have a chance to make headway is within non-PA schemes that are open to offering more choice to members. Certainly the clamour for a diversity of assets represents an opportunity for multi-managers, as they can neatly develop risk- based diversified growth strategies that cover equities, bonds, private equity, property and other alternative assets.

Julian Webb, head of DC at Fidelity, says: “Many schemes are embracing greater diversification, building their default fund around a global diversified type multi-asset fund. We are now offering white-labelled multi-manager funds, constructed for the pension scheme members, by the pension scheme sponsor, with expert input from both consultant and investment platform provider.”

Michelle Cracknell at Skandia, one of the pioneers of multi-managers, says: “Risk-based strategies are also proving popular – our Spectrum funds have taken over £100m in new money since launch in April last year – which shows demand for new solutions that match client risk profile.”

She adds: “These strategy-based funds have also performed well during the credit crunch. Skandia’s UK Strategic Best Ideas was the top performing fund in the UK All Companies sector in 2008 [it returned a loss of 11.62 per cent over the year compared to a loss of 17.7 per cent for the next best performing fund] – this shows that funds with the flexibility to utilise investment strategies such as shorting have done well during the credit crunch and market volatility.”

But again diversity is not the only wish for pensions schemes – controlling volatility and risk is of paramount importance. Yes, traditional multi-managers have the ability with careful manager, fund and asset selection to manage volatility – but so do the new breed of absolute return funds, and they could be a threat.

Dow says: “At the same time though, employers and advisers have recognised that to leave a loaded gun in the hands of the untrained – in this case a top performing high alpha fund in the hands of the investor who genuinely believes that past performance is a guide to the future – would leave them with possible legal issues where they still have some responsibilities. What we are seeing is an increase in the number of ‘risk controlled’ or maybe more accurately ‘risk caterogised’ funds. These are not necessarily multi-manager funds – they are target return or absolute return funds.”

MOM OR FOF?
In general, the multi-manager proposition is divided into two – manager of managers and fund of funds. A manager of managers (MoM) fund is an altogether different animal and is more akin to how institutional pension funds are run.

A MoM hires different fund management groups to run bespoke segments of portfolios according to a set mandate, rather than investing in off-the-shelf unit trusts or Oeics. Those offering managers of managers include Abbey (Santander), Frank Russell and SEI Investments. A fund of funds is a single fund whose underlying portfolio is made up of a collection of Oeics and unit trusts. These can be further sub-divided into “fettered’’ and “unfettered’’ funds – fettered being in-house funds only.

Not surprisingly, each camp claims to have advantages over the other. Managers of managers argue that they are more easily able to control risk. Legal agreements are drawn up to define how each segment of a portfolio is to be run. If the manager strays from this benchmark or underperforms they can be sacked. But advocates of funds of funds question whether managers of managers are getting access to the best managers.