Managing to stay on top

Manager of manager operations appoint external managers to run a pension scheme’s funds, which can reduce administration and the burden on trustees, but this may come at a cost, says Ceri Jones

Once a rarity, Manager of Managers (MOM) operations, which provide access to a range of investment managers’ specialist expertise, are now beginning to dominate the provision of investment for pension schemes.

The aim of the Manager of Manager, or multi-manager, concept is to provide a full portfolio management service inside a wrapper, with the multi-manager picking off the best of breed managers and making all decisions about when to hire, terminate or switch between funds. It is based on the understanding that as the investment world becomes more sophisticated, for instance as foreign markets open up and investment instruments themselves become more complex, so no one asset management house can excel at everything.

Another big attraction is that monitoring investment performance is a full-time occupation, and a multi-manager does that for employers. This burden has become particularly acute since the start of the decade when not only have good returns been hard to come by, but investors began to focus on the diversification of investment risk, a complicated matter of comparing assets by class, region, style and by the individual manager.

Employers come into contact with multi-managers in two ways. Those with trust-based pensions, such as final salary schemes, may select a multi-manager to take full control of their assets, either by selecting pre-existing funds or, if the pension is large, by putting together segregated mandates specifically for that scheme. Both set-ups go a long way to relieving trustees of the burden of making continual investment choices. Instead, those decisions are executed by professionals who are constantly watching the markets. Day-to-day administration may also be reduced by the existence of a single point of contact.

The biggest growth in MOM use is coming from contract-based defined contribution pension schemes, such as group personal pensions. Most contract-based pension providers now offer this choice to employers. A difficult decision for organisations providing contract-based schemes is the level of investment choice to offer members. Pension providers generally offer a wide choice of investments for employers to draw up a shortlist from. Presenting members with a vast range of options can be confusing, so many consultants believe five-to-eight funds are ample.

One drawback of multi-managers is their high charges, as they impose a second layer of fees for their monitoring activities. While competition has helped drive down charges since the 1990s, multi-managers still carry total expense ratios (total charges) of 2%-3%, compared with 1.5%-1.7% for traditional funds. This may not sound much but it mounts up over the life of a pension plan as the compounding effect kicks in.

The crucial test for any investment is how well it performs. As with other investments, some multi-manager funds have consistently outperformed their sectors while others have underperformed, but it is a difficult area to monitor and the resulting lack of analysis is often commented upon. Generally, multi-manager appears to work best over long periods but not during inflexion points or when stocks are rising driven by factors other than fundamentals, such as the last few years’ global liquidity.

Nic Round, managing director of independent adviser Murray Round, says: “The issue is: will multi-managers make you better off, or are they just another layer of costs that someone is going to pick off with nothing to prove the funds are going to outperform? Where they add value is more to do with regulation.”

Capacity constraints may also impact on performance. As multi-manager funds get larger, they may be tempted to go for third-rate opportunities just to be fully invested. A handful of multi-managers close their funds at a certain critical mass, so they remain small enough to be able to limit themselves to the best strategies. Matthew Tee, senior investment consultant at Watson Wyatt, says: “Our view is multi-manager is a compromise. You pay an extra layer of fees but use someone else’s expertise to manage governance. The industry is marked by two camps: firms that are focused on asset gathering, who manage more assets than we like to see and who find it difficult to access capacity-constrained opportunities, and firms [known as] boutiques focused on unconstrained high alpha managers whom we like to close funds before they get too big.”

This has led to a trend for certain boutique-style multi-managers to unbundle their fixed charges, and even levy explicit performance fees, so they can pay sufficient incentive to the managers of small underlying funds.

If you read nothing else read this…

  • Manager of Manager (multi-manager) uses a specialist manager to select investment managers for various assets.
  • In theory, the concept should offer pension schemes access to the ‘best of breed’ manager in any asset class and also alleviate the monitoring burden on sponsors and trustees.
  • Despite the popularity of the model, however, multi-manager performance is erratic and fees can be expensive.