Multi-manager with a difference
In the rapidly expanding world of defined contribution (DC) pensions, the concept of multi-manager is no longer new. But this doesn’t mean that multi-manager has lost its gloss or its relevance. The leading providers are developing new features and improving existing ones all the time.
The case for multi-manager is very strong. A pension provider can offer the members of a DC scheme three levels of investment diversification. At the top level they can choose between the main asset classes: equities, fixed interest, property and cash. At level two the choice lies between the different management styles: growth, value, small cap, et al. The third and final level offers the ability to choose between different fund management houses – the ‘multi-manager’ approach. This is based on the reality that nobody can be best at everything.
There is a close analogy with team-based sport, where it is strength in every position that matters. A football club that has the most talented strikers in the league will go nowhere unless it has defenders, midfielders and wingers of matching high calibre.
The transfer market enables the management of a professional sports team to strengthen its squad by attracting talented players from outside. Likewise an investment management house, which also acts as a DC pension provider, can widen the spectrum of funds it offers to clients by adding to it from the ranges of other managers. In doing this, I believe it should consult widely with its clients, both existing and potential, and the consultants who advise them.
The end result is a master menu consisting of, say, some 50 portfolios from which an employer, working closely with its adviser, can select its own list of 10 or 12. Employees/ members are then able to pick and choose from this scaled down bill of fare to achieve their retirement income goals. They don’t do this in a vacuum. There is an ongoing programme of education and communication to ensure they have the knowledge and information they need to make decisions of the informed kind.
The sizes of these menus are not set in stone. However, I believe that a master list of 50 or thereabouts is about right. The choice on offer is large enough to comfortably cover the three levels of diversification without being too complicated and unwieldy. The composition of the master menu will probably evolve over the years, as the investment management house/DC pension provider responds to client and adviser demand by removing funds that are falling behind their benchmarks and adding those that are moving the other way. But its overall size will remain about the same.
According to the Plan Sponsor 2000 DC Survey, 6% of DC arrangements in the US offer a bewildering selection of 25 or more funds to employees/ members. I believe, however, that a sub-menu of 10 or 12 portfolios should offer a more than adequate platform to enable individuals to achieve their retirement objectives without unnecessary complexity and scope for confusion. Bear in mind too that the availability of lifestyle switching programmes, typically out of equities and into bonds and cash, effectively widens the choice.
Retracing our steps to the master menu, what types of funds should it contain? The portfolios should cover all the main asset classes: cash and property as well as equities and bonds. Cash can act as a haven at times of stock market uncertainty and, in the run up to retirement, as a way of consolidating previous gains whether within a lifestyle switching programme or outside. There are strong arguments for using an institutional money market fund instead of simply placing it on deposit.
There can also be a powerful case for including commercial property in a diversified pension fund portfolio. It is a distinct asset class with a record of performance that is quite different from equities, bonds and cash. Rental yields tend to move steadily upwards while capital values have a pattern of fluctuation all of their own. In some years property outperforms other asset classes. In others the reverse is true. Property fund management requires special professional skills.
This leaves a wide selection of equity and bond funds. Some of these will be actively managed while the managers of others will adopt a passive approach. At a superficial level, active funds focusing on particular geographical areas or sectors as well as those with a wider international mandate may appear to have few differences between each other, but delving beneath the surface will often reveal distinct variations in their composition. There will also be a choice of styles, so that employers and their advisers can opt for growth, value, small cap, and so on – whichever they prefer. On the passive side, the selection on offer may include funds that track a variety of geographical and international indices.
The management of at least one of the equity portfolios may adopt socially responsible investment (SRI) standards, to meet growing member demands for this type of facility. The call for SRI funds is likely to increase over the years ahead – not only because pension scheme members are developing social consciences and becoming more environmentally aware, but also to meet regulatory requirements. Already the regulators in the UK insist that occupational pension schemes prepare a written statement of investment principles, including details of ethical investment. When eventually adopted, the Draft Directive on Supplementary Pensions may well extend this requirement to all the states of the EU.
The SRI option is one recent development in the multi-manager field. There are also a number of others. To achieve competitive advantage, an investment fund management house/DC pension provider may offer unrestricted access to portfolios managed by other institutions, including funds that compete head to head with its own. There is no requirement to place any part of a scheme’s assets in its own in-house funds.
Money invested in the portfolios of competitors attracts no charges over and above those of the external manager. Lifestyle switching programmes can be based entirely on out-house funds, with no minimum proportion having to be invested in the portfolios of the multi-manager host. And there are no restrictions on the selection of a default fund. This can be from the in-house range or from the guest selection on offer. Employers – with guidance from their advisers – are free to choose.
The concept of multi-manager may not be new, but there will always for scope for improvements, some minor and others more radical. The challenge is to search them out. Also multi-manager will not achieve its objectives on its own. It needs to be backed up by a programme of member education and information, an efficient administration system and a choice of communication media.
David Butcher is chief executive of INVESCO Pensions in London