Once asset allocation is determined, multi-managers should assess the skill and expected return of potential underlying fund managers by means of criteria that are more predictive than short-term performance within a peer group. The level of skill and talent of the manager, the extent to which they have beliefs and how they are articulated and the manager’s ability to think laterally are all factors that should be considered. An overall feel for the manager’s style and ability can be pieced together through a qualitative analysis. Reference can be made to past performance but this serves only to inform the overall view of a manager’s potential ability and is not the primary basis for decisions.
Managers should be considered in the context of a full business cycle and the investment style rotations that may be part of that cycle. The final choice of an underlying manager within a particular style category is important but it is also crucial to ensure that the portfolio is exposed to the major style categories within a market. This should ensure exposure to a wide range of potential opportunities.
Once preferred managers within particular asset classes and investment styles are identified, the key issue becomes how to blend these in the overall portfolio. Blending complementary investment styles is intended to smooth out the rougher edges of the short-term volatility of individual manager returns. The key is to combine managers whose styles promise to deliver returns that have relatively low correlation with each other.
This lack of correlation makes it likely that some strategies can be expected to underperform in the short term. Short-term underperformance is often perfectly consistent with a manager’s style and medium to long -term objectives, reminding us that fund manager selection is more complex than simply picking those who have recently outperformed.
Most talented managers apply their philosophy consistently regardless of whether it produces short-term results. Stocks rise and fall for a variety reasons, many of them random in the short term. It takes nerve to retain strategies which may be underperforming but if they have been selected via a forward-looking and holistic assessment, the multi-manager will probably stand fast. Short-term fluctuations in valuation are part of the challenge that investors have to deal with.
The right decision for a multi-managed portfolio is to focus on talented managers who one believes will outperform over the medium to long term and blend them together so complementary styles and approaches are present. This should help reduce volatility and expose the portfolio to a wide range of sources of return.
Nicholas Pothier is a multi- manager at HSBC