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Multi choice

What&#39s in store for the funds of funds industry this year?

I feel it is important to define my terms of reference, particularly in such a diverse sector. I am responsible for multi-manager investment at Henderson Global Investors, where I run a range of funds of fund portfolios alongside a more traditional multi-manager portfolio service. When I mention funds of funds, I speak specifically about unfettered multi-manager portfolios.

Demand for multi-manager portfolios was not high last year but demand for any type of investment was low. What was notable, though, is the rapidly increasing number of multi-manager providers in the marketplace. This could be a result of investment houses seeing that multi-managers provide them with an additional means of diversification not available through their own in-house range.

But it is more likely to be a recognition of the growing importance of multi-managers in the world of investment management.

Whatever you feel about Sandler&#39s recommendations, there is a strong chance that many intermediaries will outsource the fund management aspect of their business to some degree in the near future.

A core proposition

We have seen multi-managers being used more and more by intermediaries as a core proposition for client portfolios. Around this core, IFAs attach additional satellite funds to create an overall bespoke portfolio geared towards specific client needs. Look no further than the recent alliance between Bates Investment and Axa for an example of this. Axa provides the core proposition for Bates&#39 clients while Bates provides the fine-tuning.

If such a trend continues and grows, there will be a greater need for consistency among providers.

Transparency, consistency and understanding will be key attributes in the sector as usage changes. Intermediaries may well be advised to think twice about the more aggressive funds of funds that tend to trade more actively if they want to use multi-managers as a core proposition. If funds of funds are used as a core product, then the expectations of the intermediary and their client will need to be carefully managed.

Competition

The increasing number of providers fuels competition and when this happens, price bec-omes a more important issue. Attention also turns to price when negative returns are being generated as we have seen recently in light of the market conditions. We expect to see many more stra-tegic ties as price becomes more important. The problems arise with the vast array of multi-manager offerings, which cloud definitions and prevent clear likefor-like comparisons.

There are two distinct camps in the multi-manager arena – managers of managers such as Axa and Frank Russel and investors in managers such as Henderson Global Investors and Credit Suisse Asset Management. One is all about writing mandates and monitoring, the other is about finding and backing existing funds and the skills of their managers. I believe there is still a strong demand for familiar names and familiar houses among retail investors but this can be a more expensive approach.

Asset allocation

I believe that, from an investment perspective, providers will need to place greater emphasis on reviewing their asset allocation policies. What worked during the 1980s and 1990s may not work now. Certainly, the past three years have put pressure on all investors, including portfolio managers. Over the past few years, the real determinant of performance within funds of funds is the strategic allocation, in other words, the asset allocation split between cash, equities and bonds.

The restrictions surrounding control ranges and mandates determines the level of success or failure in what is a very mixed sector. While managers review the allocation of traditional asset classes, the FSA is reviewing, through its recent consulting paper, the restrictions imposed upon managers of collective investment vehicles. Within this, there is the possibility that fund of fund managers may be able to exp-and upon the current asset allocation classes available.

Given the prevailing market conditions and the expectations of many managers for single-digit growth over the coming year, things are going to be difficult for the multi-manager. As in 2002, you will continue to see funds of funds using less benchmark-restricted funds in pursuit of greater returns relative to the peer group. This could in turn lead to some funds of funds managers taking more risk to generate returns.

I can see a period of consolidation as providers compete for the top spot. I am sure that Insight&#39s recent purchase of Rothschilds and, in particular, the Five Arrows Portfolio Management Service will not be the last of such acquisitions.

One of the key factors in successful multi-manager propositions is funds under management. Size brings plenty of advantages. In current conditions, building a multi-manager business from scratch is going to be extremely difficult. New money is scarce and existing assets are likely to be falling in value or to have fallen dramatically in line with global market indices.

If you cannot build a business through attracting investors, you can always simply acquire an existing business. Such an avenue also allows you to expand your resources through the acquisition of an experienced and established team as well as clients and assets under management.

The rapid increase in providers last year has created a more competitive environment. Competition brings change that should benefit investors.

But while usage of multi-managers is set to change, the customer needs to be clear on the proposition. Multi-manager offerings will need to be flexible and the potential for regulatory change could allow funds of funds managers to expand their proposition.

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