The closure of final salary schemes, the Equitable Life debacle and the demise of traditional balanced funds have led to an increase in uptake of manager of manager funds
The investment market is experiencing a period of unparalleled change as investors come to recognise that the era of the safe haven is over.
Too many safe havens for individual investors have proved anything but that. The closure of final salary pension schemes, the reneging on guaranteed annuity rates by Equitable Life and the near-wholesale failure of with-profit funds to meet their targets are just a few of the massive dents in investor confidence the retail industry must now repair.
The institutional sector has fared no better with segregated pension funds still reeling from the Merrill Lynch versus Unilever fall-out and pooled managers facing the inevitable demise of the traditional balanced fund that has generated such poor absolute returns since the end of the bull market.
The subsequent flight to index funds in the retail and institutional sectors has proved equally disappointing, as investors come to realise that funds correlated with traditional equity markets are, by definition, bound to fail to achieve satisfactory returns when markets are falling and that while a tracker reduces relative risk, it does not reduce absolute risk.
The fact that the passive manager cannot take a defensive position by avoiding underperforming sectors or moving into cash only adds to the misery.
Unfortunately, the transition from passive funds back to active management in the retail sector is hampered by the sheer availability of products from the fund supermarkets. Fear of choosing the wrong asset managers is intensified by the general consensus that very few managers achieve consistent satisfactory results over the medium to long term.
In response to these problems, we are witnessing the emergence of new asset management structures and strategies that aim to meet the challenging conditions of the investment world.
Particularly welcome to investors and advisers is the rise of the rating agencies that grade funds in a way that paint a clear picture of the true capabilities and weaknesses of the investment managers. This clarity of information is supported by regulation that requires advisers to justify their recommendations.
With such an intense spotlight on quality, many traditional investment houses that have used in-house managers are reviewing their strategy. Typically, this may lead to the outsourcing of asset management, at the very least for the poorly performing funds where the competence of the fund manager has been called into question.
A more holistic solution that is being adopted by some of the major retail and institutional asset managers is the multimanager strategy. This alternative to the in-house approach can be structured on a manager of managers basis or through funds of funds. This trend towards multimanager coincides with the growing interest in alternative investment strategies.
The combination of multimanager with hedge fund strategies may be the solution to the apparent failure of traditional methods. Hedge funds operate in many different ways but, broadly speaking, these strategies aim to provide absolute returns despite volatility in equity and bond markets.
So how do these strategies differ?
A fund of funds simply invests in existing mutual funds or hedge funds, whereas the manager of managers usually places money with selected specialists on a segregated basis. In the case of the traditional long-only approach, the manager of managers uses specialist managers to achieve consistently low volatility returns and reduced risk compared with the relevant benchmark.
The market for this strategy was relatively insignificant until recently but in 2001, UK pension funds invested about £2bn into manager of managers funds. Manager of managers has also broken into the retail market where providers now act as third party asset managers to major retail insurers and other distributors. The latest high profile venture is the strategic alliance between Frank Russell and Scottish Widows.
The added value of the manager of managers lies in its ability to select specialist managers with superior stockpicking abilities within a closely defined and monitored mandate. Equally important is the swift deselection process ' an essential component for long-term consistency of performance.
The providers' margin is derived from the purchase of wholesale investment management at the lowest aggregate rate and the sale of funds at a disaggregated rate. Many of the overseas managers employed by manager of managers are local boutiques that are not well known or readily available in the UK.
This then is the core competency offered by SEI, Frank Russell, and Northern Trust, for example, who represent the pioneers of the multimanager approach and who have adapted their experience in the US for the UK market.
Long-only funds of funds typically aim to achieve high absolute returns by employing high profile managers, which makes them readily marketable. The added value here is the access to a wide range of pre-selected, highly rated funds via one investment vehicle. The providers' margin is derived from their ability to buy units at a discount and sell at a packaged price including a fund fee. These structures are available through Jupiter and Rothschilds, for example, which have focused on the retail market.
Fund of hedge funds structures aim to provide a high absolute return that is not correlated to an index. The way that these funds add value is through their due diligence process, selection and monitoring of individual hedge funds and by providing access to market capacity that may otherwise be restricted as funds close to new business or are simply not available to individual investors.
Their margin comes from a fund-based charge and performance fee. The best-known provider in this market is probably GAM but there are more recent prominent entrants such as ED&F Man.
Over the coming months, we can expect to see many new players offer manager of managers and fund of funds structures, both traditional long-only and hedge funds ' all striving to achieve absolute returns in what are expected to remain difficult investment conditions.
By definition, funds correlated with traditional equity markets will fail to achieve satisfactory returns when markets are falling.
A fund of funds simply invests in existing mutual funds, whereas a manager of managers places money with specialists on a segregated mandate basis.
Fund of hedge funds structures aim to provide a high absolute return that is not correlated to an index.
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