The claim that multi-managers can consistently add value through active asset allocation and market timing may be a debatable one, says investment research manager at OBSR Gill Hutchison, but it is important to understand how providers use such techniques when determining whether their funds are appropriate for clients
In our research and analysis of multi-manager funds, we have found that there are broadly three different approaches to asset allocation - fixed asset allocation, relative return bias; active asset allocation, relative return bias; and active asset allocation, absolute return bias.
These categorisations help to distinguish between those managers who believe it is not possible to add value consistently from active asset allocation and market timing, those who believe they are able to add value from taking strategic or tactical asset allocation positions within a relative return framework and those who actively asset allocate with a view to generating absolute returns over the long-term.
We have found that the majority of providers fall into the category that we describe as 'active asset allocation, relative return bias'. This category includes managers who believe they are able to add value from strategic and/or tactical asset allocation as well as from manager selection and this tends to be a popular hunting ground for funds of funds managers.
However, we acknowledge that even within this category, there is a range of different approaches and we therefore thought it would be worth looking at this grouping more closely to determine how active asset allocation strategies can vary and how much flexibility is actually used. For those multi-managers who count strategic or tactical asset allocation as part of their value proposition, it is also important to consider what expertise and resources they have to support them in their aims. As a point of note, we consider strategic asset allocation to be longer term in nature while tactical asset allocation is generally perceived to be more opportunistic and short term in nature.
Modesty in asset allocation
Firstly, we can consider those multi-managers who take only modest asset allocation positions away from benchmark - F&C and Fidelity are examples of such managers:
F&C manages its range of four funds with reference to the positioning of the relevant peer groups and monitors these statistics closely. The manager typically uses a tolerance of plus or minus 4% to allocate actively to regions and he enjoys the input of the strategy group and internal fund managers to help him formulate his views. Ultimately, however, the manager primarily seeks to generate returns that demonstrate low relative volatility and consistency.
Fidelity operates with similar regional guidelines of plus or minus 5% and positions its funds according to a minimum risk asset allocation model - that is, a position that minimises tracking error versus the peer group median.
In both cases, controlling relative risk from asset allocation is a key factor in the managers' approaches. Consequently, most of their scope for added value comes from their success in manager selection and blending, as well as any style and market cap preferences they may adopt. Philosophically, such managers have more in common with those who believe it is difficult to add value consistently from market timing.
Asset allocation in action
Next, we can consider managers who use asset allocation more actively as part of their value proposition. There are several funds of funds managers in this space but we will focus on Credit Suisse, Gartmore and Insight for the purposes of this article:
Credit Suisse offers a broad range of multi-manager funds, which was extended after its purchase of the Artemis Premier Funds range. While the managers seek to generate alpha from their decisions on asset allocation, they take controlled positions on the basis that clients would not expect them to stray too far from their chosen strategy. The multi-manager team benefits from the input of Credit Suisse's considerable resources with regard to investment strategy but also draws from other sources in the course of their work to arrive at the preferred asset allocation positions.
For Gartmore, asset allocation is also seen as an important aspect of the fund offering and it estimates that approximately 25% of its excess return can be attributed to this part of its process. The multi-manager team works with a trusted colleague who has a great deal of experience in asset allocation. Its decisions are based upon fundamental analysis and it tends to be longer-term in its outlook. The team is also highly aware of portfolio risk, not only on a relative basis but also on an absolute basis.
The Insight multi-manager process is structured around the disciplines of 'locating alpha' (manager selection) and 'enhancing alpha' (active asset allocation). Insight has taken care to articulate clearly the guidelines for the strategic asset allocation, the tracking error range and the out-performance targets for each of the funds (although we note that the Diversified Target Return fund has different parameters). Insight's tactical asset allocation decisions are taken against a framework of input from the group's in-house strategy decisions and the multi-manager team's own deliberations, with the help of a proprietary analysis tool. The multi-manager team has a strong awareness of risk from a qualitative and quantitative perspective and the Diversified Target Return fund, which was launched in February 2005, draws heavily from its tactical asset allocation skills.
Pushing out the boundaries
There are fewer multi-managers who push out the boundaries further in terms of tactical asset allocation within a relative return world but we consider New Star to be operating at this end of the spectrum.
New Star offers a range of funds that are managed with the aim of generating attractive relative returns, although the Tactical Portfolio is managed without restrictions and with an absolute return mindset. New Star counts as one of the most active and market sensitive multi-managers that we cover and tactical asset allocation is a key part of its process.
The team is autonomous within New Star and while it may seek input from internal sources, it is not bound by house strategy. The team has been operating in this manner for many years - previously at Edinburgh Fund of Funds - and its members use information and analysis from a variety of sources to help formulate their investment strategy. They frequently invest in specific country funds or in sectors where they have strong views but at the same time, they remain cognisant of the contribution of higher risk positions to the risk of the overall portfolio.
Furthermore, guidelines restrict the team with regard to asset allocation positioning and tracking error ranges versus peer group benchmarks - again, in all but the Tactical Portfolio. Nevertheless, within these guidelines and risk controls, the team uses any flexibility available to capitalise on its high conviction ideas.
Understanding the approach
In conclusion, even within the narrower group of multi-manager funds that we categorise as 'active asset allocation, relative return bias', we can see that there is a variety of approaches to strategic and tactical asset allocation. How effective active asset allocation and the timing of markets is over the longer term is always a matter of debate and a question that is only ultimately answered by the success or otherwise of the managers who operate in this sphere. Most of us have our own ideas about this, but we can at least take steps to understand how managers use asset allocation, what their credentials are and determine whether such funds are appropriate for our clients.
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