Just how many coffee shops can exist on one high street? Five years ago, coffee shops were considered a luxury option by many shoppers but now they seem to be on every street corner. Pardon the analogy but this seems to be exactly what is happening in the world of multi-manager. Just how many operations can survive over the long term is a matter for debate. After all, there are only so many ways you can grind a coffee bean and make it taste different with flavourings and milk. It is consumers that will dictate those operations that succeed and those that survive.
But we are clearly some way from the consolidation phase. Most major investment companies have joined or have plans to join a seemingly unstoppable bandwagon and it is not difficult to see why. The marketplace for multi-manager products is growing at breakneck speed. Stockmarket volatility, huge fund manager turnover and performance inconsistency, as well as increased regulation and compliance issues for advisers, are driving growth. There is a recognition that outsourcing to specialist multi-manager funds is good business practice for many. Ultimately, it will be consumers that benefit, with competition keeping providers on their toes.
But like coffee shops, there are seemingly endless options now available in the multi-manager marketplace and providers have to do a better job in explaining the differences so that the growing amount of choice does not end up causing so much confusion that people pass by the shop instead of walking in.
Everyone now knows the difference between espresso and latte but less so between funds of funds and manager of managers. Consumers must be helped to choose what is more appropriate for them.
To understand the differences between the two main types of product, one really needs to look at the origin of Fofs and Moms. Both provide comprehensive one-stop investment solutions and both believe in the benefits of diversification, since no one company, manager or individual has a monopoly on talent and knowledge. Fofs have their roots in retail private-client fund management while the origin of Moms is in the institutional consultant-driven pension fund business. This is crucial to the debate, with much of the confusion that exists in the marketplace being caused by providers on one side of the debate trying to sell to clients of the other.
If you think about it, pension funds have one key responsibility – to ensure there is enough money in the pot to pay out future expected liabilities, known as asset liability matching. A pension fund will have a certain return to achieve over a usually long time horizon and this will set the boundaries for investment in, for example, equities, using historic long-term market returns from various asset classes to dictate asset allocation. The manager of the pension fund will therefore not want to take significant additional risk with the equity content since he will not want to fall foul of his return requirements. Hence, a Mom provider is most keen to generate returns from equities at least in line with the index, with modest outperformance year on year being the desired objective. It then seeks modest yearly outperformance net of fees from careful manager selection, with little or no overall investment style bias.
It is not surprising, then, that Mom providers performed well in the 1990s as a strong bull market made it difficult for active managers to beat indices. Moms are therefore appropriate for long-term pension funds and perhaps for some retail investors who believe that equities are once again in a strong bull market, with large index stocks likely to drive indices higher year on year.
I do not believe that we are now in such a stockmarket environment and, indeed, we have not been so since 2000. Markets are most likely to be characterised for at least the next few years by increased volatility, with some up years and some down years, just like the 1950s.
In such an environment, I firmly believe that this will be the decade of the active manager. Flexibility to hold more cash and invest away from the index will be crucial and good calculated risk taking will be rewarded. If this is the case, then I fully expect Fofs to continue outperforming Moms, as they have done for the last few years. As such, it will probably be harder for Moms to break into the retail area, since the investment time line for the retail private-client investor is usually much shorter and modest outperformance of an index that might end up going nowhere for lengthy periods will simply not be sufficient.
So the performance of Fofs and Moms varies primarily according to stockmarket conditions. Which one you choose depends on service quality, efficiency, clarity of explanation and, above all, all-round performance. On the subject of price, we all know that being slightly cheaper does not always guarantee satisfaction.
Gary Potter is director and joint head of Credit Suisse Multi Manager Services