Multi-manager has proved a hit with investors who are attracted by the concept of an investment professional trawling a virtually limitless universe to find the perfect combination of funds for their portfolio. However, unrealistic expectations and lack of understanding of the methodology could ultimately lead to a flood of redemptions.
It is a popular misconception that the additional tier of management charge levied on multi-manager products is paid so that the manager can find the best-performing funds and combine them in one portfolio. Not only would this constitute an exercise in hindsight but it would fail to deliver the consistent returns that the multi-manager approach is designed to offer. If all the components outperform at the same time, there is a danger they could also simultaneously underperform at some point in the future.
In this scenario, we would be talking about a cluster of funds with similar characteristics which anybody could put together, rather than a complementary and risk-diversified portfolio of uncorrelated investment disciplines. To put together the latter, extensive qualitative research and quantitative analysis is required.
Qualitative research is essential in determining how a fund manager or investment discipline is likely to perform in a variety of market conditions. Quantitative analysis is backward looking but can form an important part of the fund selection process as it allows the factors that have contributed to, or detracted from, relative performance to be analysed in detail and can therefore help to verify the findings of the qualitative research.
The knowledge obtained from the research and analysis can be used to build a portfolio of investment disciplines that are uncorrelated. An effective multi-manager product should be characterised by above-average relative performance, a low tracking error and high information ratio. Strong short-term performance would therefore be indicative of a weakness in portfolio construction rather than a successful investment process.
Multi-manager provides a valuable dimension to investors’ options. The argument that index trackers merely provide “guaranteed mediocrity” remains valid. Innovations in the way products are constructed to overcome these issues means some more traditional methods of measuring managers’ effectiveness must be reconsidered, otherwise investors will become unjustifiably disillusioned with their portfolios and potentially seek alternative solutions that could be less suitable and less profitable.
James Hughes is head of multi-manager (UK and offshore) at HSBC Investments.