Home > News > 2002 > November 2002 > Barnett Waddingham Investment Note - Manager-of-Managers
Barnett Waddingham Investment Note - Manager-of-Managers
This article discusses the relatively new (from the UK perspective, at least) area of manager-of-managers in the UK pension fund investment market.
There are a number of manager-of-managers (MoM) operating in the UK pension fund investment market place currently and it seems that the MoM approach is set to increase in popularity. This note introduces the concept of MoM for those who are not already familiar with this, and also described some MoM market analysis that Barnett Waddingham have recently undertaken.
What is the manager-of-managers approach?
A manager-of-managers undertakes research of the market of investment management houses in order to identify firms, or individuals within those firms, who they consider to be the best available specialists for different asset categories or different investment styles. The research is normally conducted constantly (or at least very frequently) and might aim to identify specialists for very broad categories of investment (e.g. a good manager of global equities) or far more narrow categories (e.g. a good manager of small UK growth stocks).
Having identified fund managers who they consider to be the best available they bring them together to manage pooled funds set up in the manager-of-managers name. The MoM funds will therefore perform in line with the performance of the chosen underlying managers. If and when the MoM changes their opinion as to who the best managers are then they can remove and appoint new underlying managers.
A MoM might change managers because they are concerned that a particular manager is no longer the best available in their particular area (perhaps because key personnel or processes have changed, or perhaps because a better alternative has become apparent) or alternatively because a manager's style has changed and they no longer fit with the particular MoM approach.
A MoM approach usually involves appointing different managers who complement each other by using different strategies or investing in different types of stock. For example, one manager might be appointed who uses a "value" style of picking stocks and another who uses a "growth" style. By using complementary managers the MoM approach expects to achieve less variable returns relative to the underlying benchmark than any single manager alone (because, for example, at times when the value manager may suffer from poor performance due to value stocks being out of fashion then this might be compensated by the growth manager's performance to some extent).
However, the MoM approach is not trying to cover the whole market (in the same way that an index-tracking approach does) and by only appointing those managers who they believe to be the best specialists in their particular area they hope to generate better long-term returns than the market as a whole.
Typically the MoM approach involves appointing two or three different managers to each of the MoM funds, but sometimes more managers are used. Much research has been undertaken by MoM firms on the theory of the optimum number of managers to utilise, although there remains no consensus on this.
The MoM approach can be more costly than traditional active investment management, principally because the cost of the research of the MoM has to be met in addition to the fees of the underlying investment managers. This would be expected to be reflected in high annual management fund charges. The MoM firms expect that their approach will generate sufficient performance to more than offset the extra research costs but this is not guaranteed and, in practice, the MoM approach can deliver better or worse performance, net of expenses, compared to alternative investment approaches over different periods of time.
An offsetting factor on costs is that trustees and their investment advisors might be able to reduce their own "investment research costs" if they are satisfied that the necessary research is inherent within the MoM approach. Indeed, the MoM approach often involves investment research conducted with a frequency and level of detail that trustees or their consultants could not normally aspire to.
Furthermore, a MoM may obtain better terms for particular underlying managers due to the economies of scale resulting from their pooled fund arrangements.
What research has BW undertaken?
There are a few leading MoM firms and a few other "fringe" players. BW have interviewed a number of firms, constituting the vast majority of the MoM market, as well as undertaking our own academic and statistical research. We have established the following factors as being the key considerations in assessing a MoM approach:
- A true MoM approach is not just a collection of other managers' pooled funds (a "fund of funds") but is based around segregated portfolios managed by particular firms or individuals according to specific guidelines set by the MoM.
- A MoM approach should seek to diversify the "style risk" of the underlying managers in some measure (so that the MoM fund should not have too much bias towards a value style or a growth style for example).
- There is a balance to be struck between having sufficient managers to obtain style diversity but not so many that the managers begin to overlap and introduce unnecessary transactional costs, or indeed so many that the fund tends towards becoming an index-tracking fund (but for a far greater fee!).
- A MoM approach needs to be supported by a research capability which has both the depth and experience of resources to review the investment management market continuously and in sufficient detail.
- A MoM approach must be supported by a range of fund options that enables pension schemes to implement a bespoke strategy that is suited to their own liability profile, risk tolerance etc.
- A MoM approach must be fully supported by appropriate administration, reporting, support and custody arrangements.
- The fees charged must be commensurate with the likely value to be added from the MoM approach.
Should UK pension funds be considering the MoM approach?
In our view the MoM approach has many attractions and it is something that pension fund trustees should consider when they next review their investment strategy. It is currently utilised by many pension funds overseas, particularly in North America, South Africa and Australia.
The MoM approach is genuinely "active" in the sense that experienced investment professionals are continuously monitoring the composition of the portfolio and individuals charged with the day-to-day selection of stocks. Arguably this means that the MoM approach may reduce the "manager risk" inherent within an active strategy (meaning the risk that the portfolios underperforms its benchmark for a sustained period of time due to poor performance of a particular manager).
That is not to say that all pension funds should be taking more active investment management risk. Many pension funds may settle on a passive approach to investment or else they may decide that a balance between passive and active approaches is appropriate. In this case they might use the MoM approach for the active part of their portfolio in conjunction with a passive manager for the remainder of the portfolio. An advantage of this compared to the traditional single manager approach is that active management fees are only paid on that part of the portfolio that is genuinely active and lower passive fees are paid on the remainder. Furthermore, far more control can be seen to be exercised over the active portfolio.
The MoM approach is also consistent with many of the Myners principles, the implications of which all UK pension fund trustees are currently considering. For example, the MoM approach automatically ensures delegation of key investment decisions (such as the hiring and firing of the underlying managers) to professional specialists, thereby taking many of the more difficult decisions (and those requiring significant time and expertise) away from the trustees. The MoM approach also provides a natural break between the actuarial advisors (who would be expected to contribute to the discussion of asset allocation and active-v-passive approaches for example) and an investment advisor (i.e. the manager-of-managers) who implements the chosen strategy.
For further information on the Myners principles please refer to Barnett Waddingham's detailed guide for pension fund trustees.
Appointing a manager-of-managers
There are a number of MoM firms in the market, as mentioned earlier, although only a relatively few of these would normally be regarded as the leading players currently. Trustees could choose to interview a number of MoM firms (perhaps by having a "beauty parade") and make their own assessments relative to the kind of criteria discussed above.
However, Barnett Waddingham are conscious of the time and cost that can be spent on a beauty parade process, and also that many trustees often do not feel qualified to distinguish between different (but often similar) investment approaches. In the light of this Barnett Waddingham have established a preferred provider of the MoM approach in order to offer clients a reduced-cost entry into the MoM market.
Based on our research of the market and our assessment of the criteria listed above we have selected SEI Investments as our preferred provider of the MoM approach at the present time. This decision will be reviewed by Barnett Waddingham from time to time in the light of changes in the MoM market.
As a result of this, clients of Barnett Waddingham interested in following the MoM approach can benefit from our own research by appointing SEI, thereby saving the cost of their own selection exercise. Furthermore, clients utilising SEI in this way will also enjoy a fee saving.
About SEI
SEI Investments is one of the largest manager-of-managers in the world, managing assets of over £50billion. SEI was founded in 1968 and is a NASDAQ listed company with substantial employee ownership.
SEI focuses its business on MoM investing for their clients. They have a dedicated resource of 70 investment professionals who have established an extensive research and monitoring process to manage the funds. SEI has a long, successful track record in the US and since entering the UK market in 2000 as a fully independent MoM they have established themselves amongst the major players in this arena.
Further details of SEI and Barnett Waddingham's preferred provider arrangements with them are available to clients on request.
Conclusion
The manager-of-managers approach will be of interest to an increasing number of pension fund clients in future as it has many potential advantages over the traditional single manager approach, combined with a high level of consistency with the Myners principles.
Barnett Waddingham, October 2002.