IFA recently brought together investment managers and research heads to discuss the trends occurring in the multi-manager space.
AMP Capital Investors investment director Sean Henaghan, Russell Investment Group Australasian chief investment officer Symon Parish, MLC capital markets research head Susan Gosling, Intech head of investments Daniel Needham and Morningstar head of adviser and research Anthony Serhan spoke to Victoria Papandrea and Vishal Techandani about the impact of the current market conditions, where production innovation is heading and what the multi-manager landscape may look like in 2020.
Papandrea: How has the current market volatility affected multi-manager funds?
Serhan: With the multi-manager products that are out there, one of the things that characterises them is lower volatility, only in a relative sense. They haven't been immune to the volatility but they have continued, as you would sort of expect, to be positioned on the right side of the risk equation relative to other single manager options that are out there, and that's partly due to the diversification base. For some of the products, if you're talking about the balance funds, it's also attributable to a diverse asset allocation that sits within them. Multi-managers haven't been immune, but I think they have continued to hold the position that you expect them to hold relative to the other players.
Henaghan: My view is a little bit different. I think it all depends on the asset class. Take for example Australian equities; in our portfolio we have a combination of six very benchmark-unaware managers and some of these guys haven't held resource stocks because they just think valuation is too extreme. So because they really had to move well away from the benchmark, in an environment where you've had some pretty narrow breadth of market, they've actually struggled with it. The other area that has toughed it out is global bonds. We've got five managers and they've got a bond portfolio and all of them are running tracking errors in excess of 250 and they've just been creamed. It's not because they've actually got low, poor credit in the portfolio; they've just got a lot of credit and the spike in the volume has really hurt them. So I think the sort of high tracking error, really risky mandates have been punished in some of the asset classes.
Parish: In our equity funds there's been a flagship fund that is almost the flipside of Sean's experience. Last year our managers probably struggled to keep up with the hallmark and then since we've moved into this more volatile period our funds are outperforming. But I think the important thing for investors that are trying to choose multi-managers or some other product is that despite that, I think the returns are probably much more consistent and there are less surprises.
Gosling: With the MLC debt strategies, despite having specialist high-yield managers, emerging market debt, it serves this environment very well and I think it comes from not simply having manager diversification but having broad mandates as well; so actually hiring managers to use their skills in terms of which segment of the debt asset space to be in. So rather than having a narrow style box and being stuck in those boxes, which can be very difficult in this environment, managers that have a breadth of skill and can move around in the debt space has been very good. While multi-manager is strong in the sense that it's got that style diversification, it needs to go to the next step and be able to use the scale and flexibility to draw more insight from a manager's skills set.
Needham: Certainly with our active funds it's been an interesting time because you've had that sell-off and it's a driver from the deleveraging that's happened offshore. I think a lot of high-quality assets have been sold off with low-quality assets because they've been sold off for liquidity reasons, and the asset you sell first is the one that you couldn't sell cheapest. That's caused a lot of high-quality assets to sell off as well so the valuations have opened up quite a bit. What we've found is that valuation strategies in the fixed income space, both from the bottom side, the currency side, on the credit side and also the equity space, they've all really struggled. So we've seen our tracking error double on a 12-month trailing basis. It's been a challenging time for fundamentally-driven investors, but also I think if you've got a diversified portfolio with a long-term focus, it's that environment that provides opportunity for those investors. So we're seeing expected alphas probably the highest they've been for three or four years.
Papandrea: How have the market conditions impacted on multi-manager fee structures?
Needham: The performance fees aren't on the negative page of the quarter, but generally when we build portfolios we focus on net-of-fees and asset performance so I think that it shouldn't have a material impact. If anything, I think it's going to lead some of the long-only managers to have some serious questions asked because there's a lack of alignment in a lot of those models. We're under continual pressure to reduce fees, it's just a structural trend that is happening and we have to cope with it.
Serhan: Given the level of assets that have now come in, and notwithstanding the market pullback, but from three to four years ago we were all managing a lot more money so we should have some scope.
Henaghan: See, I think that's a bit of a myth. Not with more money but the belief that because you've got a billion dollars, you go to an Aussie equity manager and say, 'I'll give you a billion dollars but I want to go to 20 basis points', they go, 'no we're not interested'. So you know I'd rather have $200 million and 40 basis points. In some asset classes it gives you economies of scale but some of the domestic ones, if anything it's a disadvantage.
Needham: When you've got high-quality managers who have been successful, I think they've got the power; they're the price setters if you like, whereas previously you have to give the person the capital first up. If anything, it's going to be much more challenging going forward than it has been in the past. So larger fund to funds and fund managers or people who rely on that scale, I don't think it's going to be that much of an advantage. Certainly what we're seeing from our clients going forward is the costs-plus-type arrangement where people are going to put their margin on the table and say 'this is the value-add we are bringing and this is what I'm going to be paid for it'. I think it is going to remove part of that tension in the market now between the repackaged all-up cost and what you're actually providing.
Papandrea: Where is product innovation in the multi-manager space heading?
Gosling: There's some counter-trends happening and there's more and more diversification. We're definitely seeing in the UK a concept now coming out called 'new balanced', which is the institutional funds wanting to look as though they want to go back to the good old, bad old days of balanced funds. Whether it's going to have the disadvantages of that jack-of-all-trades or master of one, I don't know.
Henaghan: The 'new balanced' concept is absolutely perfect for multi-management because you can combine, you can create and you can be the master of all instead of the master of one.
Gosling: I agree and this is the way we want to go. There was a big debate in the '80s of balance versus specialisation but in the course of that we've lost some of the benefits of having a more integrated approach. As we carve things up narrower and narrower we can find what managers are doing and a lot of the potential efficiencies, so this is one of the reasons we don't specify and we've got these really broad mandates. We're starting now to go a step further and really integrate stock selection and rationalisation. You don't have to have any one approach; you can get the benefits of specialisation but at the same time you can also have some broad mandates. So the first steps we've made in that regard is including in our regular diversified fund our own long-term absolute return strategy, which has got a very different asset allocation approach. It has an active approach looking at a five-year time frame and that's actually been very good through this adverse environment that we've had. We've also identified some managers that have complete integration of stock selection and asset allocation. So they're using their top-down and flowing that through to their bottom-up stock selection so it's not just equity, it's much broader. It's a rare skill but it takes the constraint out of the investment process and it does help us get towards a more efficient asset allocation.
Needham: We're thinking more long term and we're going more towards a greater market orientation and more away from the theoretical world. We're focused on more tax efficiency and lower costs from a total portfolio perspective. We're moving towards more single-type funds where we've got the flexibility to move in and out of strategies, so rather than going, 'well I've got an Australian equities trust and I can't shut it down', we want to be able to go, 'well we don't like Australian equities in the long term or the alpha opportunities, therefore our investors aren't beholden to that type of structure'. What looks like flexibility externally I think internally has actually created some significant barriers to being able to become more market oriented and to take advantage of opportunities. You have to add more value than just selecting managers and you need to be more market oriented and you need to have views and they can't be actuarial views which are over 30 years, irrespective it doesn't work. So we're looking to become more market oriented and it will be a combination of, 'well we think this is an attractive asset class and we think there are inefficiencies in that asset class'. We're going to appoint managers who can take advantage of it but we also need to be able to identify those but we don't want to launch a product every time we see an opportunity. So going forward it's going to be more flexibility but less marketable, individual sleeves.
Henaghan: We funded a new balanced portfolio and basically we're allocating to risk premium where we think we can compensate for returns. So it's going to be reasonably dynamic in terms of asset allocation, it's going to have buckets of cheap beta, more exotic beta and alpha and then we will sort of increase/decrease allocations depending on opportunities. The big issue with it though is that it is peer group insensitive. Now this is where agency always comes into our game; you absolutely know this is right for members' long term because it's a much more efficient way to allocate capital, but there will be periods where it will underperform the peer group and so do you want to make this your mainstream fund given the business risk? There are some that argue that peer groups are the right way to do it because it's the best of conventional thinking but I'm a little bit sceptical. I think at times we manage too much to peer group risk and not enough to what we want.
Gosling: I agree. I think this is a really important point. We're really constrained by what's perceived as normal. Investors are making really short-term decisions in the face of the highest returns so we are really constrained in what we can do and it stops us delivering the best outcome. So what we've done with our long-term absolute return fund is made it completely peer-agnostic. We simply don't work the way anybody else does and that's how we sell it.
Parish: We're thinking of ways of being able to be more opportunistic in terms of how we can capture investment products or strategies. One of the things we did over the last couple of years was to put separate research teams in place and they were going around the world trying to find new exotic sorts of asset classes that aren't picked up in traditional research areas. Another thing we've been focusing quite a while on is execution multi-managers. Cutting back on transaction costs and more tax-efficient strategies has also been a really big focus for us.
Serhan: It warms my heart to hear everybody talking about tax efficiency because I think traditionally, historically, multi-manager products haven't been the best in that space. I don't know if everybody's trying to be better and I think you need to.
Parish: I think it's actually a misconception that multi-managers are tax inefficient compared to an example where a client might invest in a bunch of different funds as an alternative, rather than the multi-manager fund. By using these techniques, often they're just a connection to a lot more tax-effective outcome that the clients could get if they wanted in an individual fund.
Needham: From a tax perspective, alpha/beta separation is a term that's being used quite a lot. I think it's actually an important concept but ... it's like a state of mind in a lot of ways. You think about different types of investment strategies but I think it's a mistake to do it physically. So the way that we're going is to try and sort of create, amalgamate an asset as much as possible and look for types of strategies that bring alpha and beta and then manage the overall risk exposure of the total portfolio . so managing your beta exposure at a total portfolio level rather than individually. Going forward we're going to be focused on bringing down transaction costs and increasing tax efficiency.
Papandrea: What will the multi-manager space look like in 2020?
Serhan: I think it will look the same. In this industry there's a lot of new terms and phrases that come and go but the core of what's happening in most people's portfolios is still largely the same. Where the multi-managers can really step up is more needs-based product development. With the scale and intellect that a lot of multi-managers have they can take that a bit further. So we're probably going to see more focus on income, there's going to be more retirees and so packaging solutions and that part of the market will be stronger.
Henaghan: I think there will be a lot less multi-manager offerings out there. I'd like to think, hopefully, there won't be this categorisation by growth incomes. It'll be about CPI-plus-type return objectives. I think the types of investments that we will be investing in will be a lot different and you're not going to be finding this whole equity finding-type of categorisation. I think that will be a lot less blurred and it will be quite different. It's going to be a lot less compartmentalised. I think the sophistication of this industry and how quickly it's grown up in the last five years, over the next 15 years it will come a long way. It will be about generating outcomes and there will be a lot more customisation in terms of client-type-driven demand. The asset allocations won't be relevant; it will be much more about just a return and risk profile.
Gosling: The concept of debt equities is on its way out; it doesn't make sense. Assets don't fit into those new markets. There are different sorts of risk involved in each of them. It's not a relevant concept. We need to communicate quite differently about it. That doesn't capture it and it will go. It will be gone in five years.
Needham: We're in an industry lifecycle that's passed the mature stage. The barriers of entry have reduced so more players are coming in and margins are falling, so I think we'll see more of a consolidation in the area. I don't think multi-managers are going to be able to be all things to all people. People are going to give it a few certain areas and I think people will need to focus on that. I'm sceptical of whether the whole equity bond thing will be gone. I think it should be, but I think it's about delivering either superannuation returns or pension returns. That's what it's going to come down to, pure and simple. Where you're in a tax-paying environment, assets will be managed a certain way and where you're in a non-tax-paying environment they will be managed a different way. I also think there's probably going to be blurry lines between fund managers and multi-manager funds in the future. Multi-managers are going to need to have more than one tool in the toolbox.
Parish: I agree and I think customisation and being able to deliver products that really suit what investors need. With all these different sort of inputs I think technology will be a big part of it because that's what we're delivering. Conceptually I think everyone's concerned with this incidence but actually being able to deliver that to lots of different types of investors with different needs is the challenge at the moment. Perhaps that's what might drive the consolidation in terms of the number of clients because maybe not everyone will be able to deliver the technological outcomes, so maybe scale will be an important part of who can actually play that game. One of the other interesting things is how people invest through retirement. This old notion that you should invest aggressively up until a certain age and then scale that down as you approach retirement is wrong. I think the industry really needs to figure out a right approach to that.
Needham: I think the trust structure is really going to be reviewed because having pulled investments in trust structures, for superannuation funds or pension funds, is not the most efficient way to do it. It creates problems. I think the segregated manager council will be a capability that most providers will have to have going forward.
