A manager of managers (MoM) is an investment management company that outsources the actual buying and selling of securities to a range of third party asset managers. The MoM seeks to add value through the selection and efficient combination of these investment managers. As such, the role of the MoM has many similarities with investment consulting. The difference is that the MoM provides a fund management product, whereas the traditional consulting model offers advice.
It is tempting to think that the MoM phenomenon is a new one. It isn’t. A number of MoM providers have been established in the UK for many years. However, it is only recently that these managers have really begun to win significant business.
The growth in assets under management has not only been amongst the established players but for a number of new companies that have recently set up shop in the UK. This has lead to a significantly increased profile for the MoM industry as a whole. It could be argued that the Myners Report in the UK, issued earlier this year, provided (implicit) support for the MoM providers through its focus on transparency and accountability. Under the traditional consulting model, it can be difficult to attribute responsibility for manager selection between the consultant and the trustee body. Under the MoM model there is no such doubt.
MoM providers charge fund management fees, which are much higher than traditional consulting charges. This raises a number of issues that can be encapsulated in the simple question ‘does MoM justify its costs?’
It is important to differentiate between MoM and multi manager structures per se. Consultants have long been advocating the benefits of employing more than one manager. A multi manager structure seeks to reduce risk in two ways, first, by reducing the risks associated with being exposed to any single manager (manager risk) and second by diversifying investment risk.
The first type of risk reduction is a simple application of not putting all your eggs in one basket. The second is perhaps the more interesting. Combining different managers will reduce investment risk because each manager will not be buying and selling the same stocks at the same time.
The tracking error (risk) of the overall fund decreases as the number of managers within the structure increases. In this model, we have assumed that there is no correlation between managers.
As the number of managers in a structure increases, the overall level of risk (tracking error) reduces. It is important to note that the biggest reduction in risk within a multi- manager structure is made in the move from a single to a two manager structure. We will return to this later.
Risk can be diversified most effectively by combining managers that adopt significantly different investment styles. This is because managers with different styles hold fewer stocks in common. The stylised graphic below shows how managers can be combined in such a way that the style biases of individual managers are neutralised in the aggregate portfolio.
Investment styles can have a powerful impact on performance over the medium term, but it is generally assumed that no investment style will dominate over the long term. In the absence of a returns advantage, it makes sense to construct style neutral structures. Our research suggests that constructing portfolios in this way, rather than ignoring style, can reduce the overall risk by a further 25%.
Style neutral, multi-manager structures are advocated by consultants and form the basis of a typical MoM structure. However, the overall package of a MoM product is typically more expensive than appointing managers directly through the traditional consulting model. Is this premium justified? The answer boils down to two issues: 1. Manager selection skill and 2. Implementation.
If a MoM or consultant has skill in picking managers, structures will become more efficient as the number of managers increases. However, this is subject to caveats on the fees being paid to the underlying managers. Investment management fees are generally charged on a sliding scale, related to mandate size. The more complex the structure the higher the overall fee.
MoM providers might argue that they have more skill in selecting managers than the traditional consultants. It is true to say that the MoM business model is more profitable than the traditional consulting model. This provides the finance to support larger teams of researchers which, it could be argued, leads to better research. In reality unless this research can be implemented effectively, it cannot add any value.
Within an MoM organisation, large teams of analysts research a broad range of managers covering areas from UK bonds to Japanese small cap equity. Typically, an MoM structure is relatively complex usually involving several managers per region or asset class. This can result in more than 20 different managers employed across a Multi-asset mandate. In the MoM approach depth of research leads to a complex and efficient structure offering what we might consider a high ‘implementation factor’.
A contrasting approach, arguably providing an equally high ‘implementation factor’, is offered by consultants, who aim to add value, by focusing research on the major mandates (such as multi-asset, UK equity, global equity, bonds and property) that are included within a typical pension fund structure. Investment managers are then combined in relatively simple structures, diversifying manager risk across asset classes by employing two or three managers. Given that the vast majority of the available risk reduction from a multi-manager structure is gained in the move from a single to a two manager structure, we regard this as providing a relatively efficient but simple structure at a lower cost. Although we do cover a wider range of specialist managers, by tightly focusing research we would suggest that the ‘implementation factor’ of such a structure is on a par with a MoM structure.
Which approach is the most appropriate, will depend on the size and characteristics of the individual fund. For a large fund, that has the resource to monitor a range of managers within the consultant-advised structure, the benefits of simplicity and cost outweigh the marginal reduction in structure efficiency relative to a MoM product. Placing all assets with a single MoM also introduces business risk of the MoM organisation, which also needs to be weighed against the marginal additional efficiency gains.
For small funds, a multi-manager structure is difficult to implement in a cost effective manner. A MoM provides manager diversification in a single convenient package. However, although the actual manager selection can be delegated, fiduciary responsibility cannot. The trustees still have the responsibility of monitoring the activity and performance of the MoM; if the trustees’ confidence in the MoM deteriorates they face with replacing the MoM in the same way as any other fund manager.
One final issue in weighing up which approach is the most suitable for an individual fund is that of conflicts of interest. Particularly, if a MoM provider is also asked to provide advice on investment strategy, which is far more important in the long run to a pension scheme than manager selection. For example, if a MoM provider says that hedge fund investing is just a fad, is this because it doesn’t believe in the rationale for investment in this area or because it hasn’t yet developed a hedge fund product?
Hymans Robertson believes strongly in the benefits of manager diversification and believes that a MoM approach can be useful in achieving this objective. However, there will be good MoM providers and there will be ‘bad’ ones with the average MoM probably producing benchmark performance (gross of fees). Our research on MoMs reveals that there are differences in the products offered by different providers in both the level of fees and in the philosophy driving the manager research process. Any selection of a MoM requires careful consideration of such issues.

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