Following a moving target
Multi-management - and, more broadly, the idea of assembled and sub-advised product, is one of the most important trends shaping today’s global fund management industry. As firms realise that the success characteristics of manufacturing and distribution are markedly different, with the former requiring skill and the latter needing scale, they are reassessing their core competencies and outsourcing what they cannot do well. A new cadre of product assemblers has risen to meet this need.
Our firm, Cerulli Associates, includes two types of vehicles in its definition of multi-manager products: traditional, long-only funds of funds - for which Europe continues to represent the largest marketplace - and what we call manager of managers portfolios. Manager of managers products are either collective schemes or bespoke institutional solutions that use multiple sub-advisors, each of which receive their mandate in the form of a separate account.
Between 1999 and 2003 - through most of which investors suffered from a bear market - multi-manager products swelled by 14% annually worldwide, while the industry as a whole remained stagnant with a compound annual growth rate of roughly 1%. Multi-manager funds held nearly $680bn (e530bn) at end-2003, and we expect our latest numbers, slated for release in late May, to show as much as a 20% rise during 2004, with most of the increase coming from managers of managers.
Among collective investments, one notable trend we continue to measure concerns the shift from funds of funds to manager-of-managers vehicles. Advocates for funds of funds rightly point out that these products are not only easy to set up and maintain, but also permit more nimble tactical asset allocation. Additionally, in Europe, funds have more tax advantages than they do in other domiciles.
Regulators, however, are increasingly critical of the fee structures within funds of funds, especially those in which most of the sub-funds belong to the sponsor. A growing number of European distributors are now arguing that replacing funds of funds with manager-of-managers vehicles, while technically difficult for most, given higher-maintenance transition management and recordkeeping, makes more sense. Not only would such products fare better with the regulators, but they also could give distributors the ability to exert pricing pressure on component costs, by shifting from sub-funds to separate-account mandates.
Several UK firms are experimenting with hybrid models that attempt to blend the best characteristics of both schemes – but we wonder whether these products will start to make less sense as they further grow in size.
Manager-of-managers portfolios continue to become more popular with institutional investors. During 2003, flows from corporate investors into manager of managers solutions nearly quadrupled, and we expect a similarly high level of net new business from institutions in 2004 and 2005. Multi-managers continue to tell us that the average size of their institutional mandates keeps rising, as an increasing number of pension schemes worldwide hand off part or all of their assets for implemented consulting. Government quasi-endorsement (such as the Myners report in the UK) and increased regulation (particularly after the fund-trading and market-timing scandals in the US) have spurred a growing number of companies to outsource manager selection. This new environment, however, also weighs on multi-managers, which now must investigate not just investment performance but also regulatory compliance, potentially doubling their workload.
With a rising amount of quantitative evidence underscoring the favourable growth characteristics for multi-manager products, everyone wants to sponsor funds of funds or manager-of-managers products. With a few exceptions, manufacturers – those already offering proprietary portfolios – will find themselves in no-win situations. Those who favour third-party product for manager of managers mandates alienate their portfolio managers; those who choose in-house portfolios, though, compromise the objectivity that investors worldwide increasingly demand.
Distributors have a more feasible shot, as they can build the scale necessary to make multi-management – an assembly function, and therefore one with margin pressures – more profitable. An increasing number are also divesting poorly performing proprietary fund managers, opening the door to manager-of-managers strategies. What distributors lack, however, is a long track record in institutional manager selection. Pure assemblers – the Russells and SEIs – may continue to dominate the space, although they will need to keep growing to maintain margins.
Multi-management already shapes several of the world’s fund management industries. It accounts for at least 10% of the Australian market, and we expect it will continue to become more prevalent throughout the world. The emerging marketplace for multi-manager products is Asia outside Japan, where a number of local regulators have removed several restrictions on such products. And we see little evidence that leads us to doubt that our long-term predictions for growth in multi-manager assets - 14% annually until 2008, with the bulk of growth shifting gradually from funds of funds to manager of managers funds - require significant revision as yet.
Ben Phillips is a managing director at Cerulli Associates, a Boston-based research consultancy