Multimanager Management

Employing more than one manager is more the rule than the exception these days. The reason for it is logical enough. Employing more than one manager immediately diversifies the fund’s risk away from the possibility that a single manager might fail, or as is often the case, move to another company. Most manager performance is a function of their specific investment style or philosophy. With only one manager, there is the very real risk that performance will go up and down over time as that investment style succeeds or fails under the changing market environment. But theoretically, if you diversify between different managers with different philosophies, this variability smooths out over time.

But a word of caution: The minute you employ more than one asset manager, the rules of the game change dramatically. Now performance is no longer a function of how well an individual manager performs, but rather, how effective the blend of managers was in meeting the fund’s objectives. This can mean that responsibility for performance falls squarely into the trustees lap. This section, then, identifies ways that trustees can shoulder this burden in an informed meaningful way.

Not only does it mean you have to think differently about who you appoint and why you appoint them, you need to have a basic understanding of what happens to both your risk profile and your potential for return when you add them together. The graphs below contrast the sources of risk/return in a single share with these same sources in, first, a fully diversified portfolio and then second, in a fund employing multiple portfolios.

The key issue relating to employing multiple managers is the fact that diversification of risk may have been so extreme that there is no potential for added value. In the example above, an uncontrolled diversification between multiple generalist managers resulted in 98% of the fund’s performance being a function of whether the market went up or down, and not from any added-value from the managers.

Rules of Thumb for Combining More Than One Manager:

Rule #1 Know what the aggregate portfolio looks like
Diversifying between funds with generalist mandates can lead to duplication of holdings and little control over whether the sum of the managers adds value.  (You may as well invest in an index fund)

Rule #2 Diversify between manager styles not just managers
Top performing managers for given periods often have similar styles. Selecting a team of top quartile managers may simply result in a compounded bet on one investment style and not diversify risk at all.

Rule #3 In selecting more than one manager, the top consideration is how they blend with other managers.
Top quartile return is irrelevant for selecting managers that blend effectively. Trustees need to determine what range of manager styles they require to achieve their objectives first, then identify which manager is best within that given style.

Rule #4 Only a controlled structure can protect against random outcomes.
Many trustees and consultants can assemble a top team of managers to blend together and then lose all potential value by failing to manage that blend over time. Because managers are constantly changing what they buy and sell, the fund must have some structure in place for dynamically managing the blend of managers.

“Who’s in charge of making the stew?”⁴²

What’s wrong with split funding?

If each of your managers is allowed to make the asset allocation decision themselves, then who determines whether all this activity adds up to something better? Surely the only possible outcome is a purely random outcome.⁴³

How to get the best from your fund manager :

1. Establish investment mandates that are totally clear and easy to follow. Identify the appropriate benchmark for the mandate.
2. Set performance expectations that are achievable and provide the manager adequate time (minimum of three years) to achieve the stated goals.
3. Organize quarterly or semi-annual meetings and provide the manager with an agenda in advance. The manager should supply all relevant documentation for all to assess well in advance.
4. Each meeting should begin with careful review of investment manager’s mission to see if any modifications of the investment policy need to be made. Any proposals for change should be made in writing well in advance.
5. Do not use the meeting to discuss:
   
   Specific purchases or sales, except where there may be a special problem.
   
   Superficial comments on the economic outlook, recent changes in interest rates or other such “show and tell” displays typically used by managers in their reportbacks. These points are effectively irrelevant in the long term objectives of the fund.

6. Do use the meeting (or the documentation prepared in advance) to assess through attribution analysis whether the manager is adhering to their mandate and to determine whether the manager is adding value through their deliberate strategies.

7. Always keep in mind that even this type of performance analysis is only statistically significant after you have 19 years of data.

8. Use one meeting a year to update yourself on the asset manager’s company and developments occurring there.

Remember that the most expensive change you can make in a fund is to change managers. Hire your managers using the care and diligence required to do anything to which you expect to make a long term commitment.

Hunker down, and make the long term commitment. (unless of course your manager leaves town…or his or her company.)