The British subsidiary of a US chemicals company held the first manager of managers beauty parade in the UK. Pension fund manager Tony Pound describes the process
One of the most interesting developments in 1999 was the manager of managers beauty parade for the £50m (e83m) equity mandate for Rohm & Haas (UK).
The company is a subsidiary of Rohm & Haas, Philadelphia, one of the largest speciality chemical companies in the world with annual sales of £6.5bn (e11bn), over 20,000 employees and 150 manufacturing locations in 25 countries worldwide.
The idea of using a multi-manager was first considered in 1992 but the pension fund manager, Tony Pound, explained that it was not until 1999 that the trustees felt the UK market was sufficiently established to make the move. What Pound hopes the multi-manager will achieve are style neutrality and proactive supervision of the fund’s managers.
The manager search led to the appointment of Northern Trust Global Investors, which runs an unauthorised unit trust on a manager of manager basis which is designed for UK pension funds.
As a landmark manager selection process, we persuaded Rohm and Haas to reveal what took place behind the scenes from the decision to review the existing arrangement, to the first multi-manager beauty parade and the appointment of NTGI over Frank Russell and Global Asset Management.
In 1991, the trustees, who are individually responsible for the management of the assets of the scheme, moved away from two balanced portfolios to specialist managers with specific performance targets. Initially, the fund was divided between the existing balanced managers, with Baring Brothers running the overseas and fixed interest portfolios and Morgan Grenfell the UK equity portfolio.
Following two years of very poor returns on the overseas equity portfolio in 1994 and 1995 the mandate was taken from Barings and in March 1996 was switched to JP Morgan. The fixed interest mandate moved to Morgan Grenfell.
Performance prior to the decision to use specialist managers had been mediocre, achieving median ranking against funds monitored by performance management analysts CAPS. During the years following the decision performance improved and averaged between 1–1.5% above median. However, all portfolios failed to achieve index returns as shown in the table.
While the decision to move from balanced management improved overall returns there was obvious disappointment that even with relatively aggressive targets the portfolios did not matched index returns. The trustees felt that they were obliged to address the situation and considered the following alternatives:
1. Move the funds to other active managers
2. Move to index funds and if so to what extent
3. Use multi-manager funds
4. Do nothing
In reviewing these issues the following points were considered:
1. The difficulties of selecting new active managers are well documented. Invariably trustees tolerate extensive under-performance before deciding to change managers and will then be influenced by the past performance of the prospective candidates.
Given the variety of factors which can influence performance there is a strong possibility that, having appointed a new manager, the style which has produced the good figures then goes out of fashion and performance nose-dives.
The constituent parts of the Rohm & Haas (UK) fund were too small to enable effective diversification over style. Having experienced first hand the effect of the above scenario – Barings performance recovered after losing the overseas portfolio whereas JP Morgan then under-performed – the trustees did not consider they were qualified, even with quality investment advice, to select new active managers who could be guaranteed to do better.
2. There has been a significant switch to index funds in the UK over the past two years which itself is contributing to the upwards move of the major indices.
The trustees hold the view that active management can still produce superior returns, which is supported by Frank Russell’s recent monograph, Adding Value through Active Manager Selection and Structure, which reported on the recent study of the period 1987–96 using multi-style, multi-manager class structures. However, whilst this conviction holds for equities the jury is still out on fixed interest.
3. The trustees had felt for some time that the relatively small size of the portfolios meant that not only was the scheme vulnerable to the ‘style’ of its chosen manager but even with that manager they were not necessarily receiving the best quality service.
This same exposure due to size was also considered a problem with the incumbent investment adviser. Rohm & Haas was Frank Russell’s smallest client. Tony Pound added, “This feeling was not paranoia! When this sentiment was expressed to Frank Russell we were referred to the chapter on ‘Managing Small Pension Funds’ in their joint publication Pension Fund Excellence by Ambachtsheer and Ezra in which they talk about small funds being less than $400m and concluded ‘It is common practice for small fund fiduciaries to try to “part-time” their way to success ... investment manager hire-and-fire decisions are made by groups of people who are not very knowledgeable about how to do that well...”
The use of multi-manager funds would achieve a reduction of risk to style and delegate the hire-and-fire decisions of fund management to qualified professionals.
4. While a recent study over a 10-year period by the WM organisation showed that many funds lose money by changing managers and that they would often be better advised to leave assets where they are, given the comments made in 3 above the trustees did not feel that “doing nothing” was a responsible option.
As a result of giving the above careful consideration, a sub-committee of four, David Angell, Andy Williamson and Sally Wilson being the trustees and Pound the pension manager, was elected to investigate what the market offered in multi-manager funds and to report back with a recommendation.
The process
Frank Russell was asked to produce a list of those investment managers/consultants that provided multi-manager capability. Extensive research revealed that there were only three contenders (at that time):
q Frank Russell Company
q Northern Trust
q Global Asset Management.
The consulting arm of Frank Russell then prepared a detailed questionnaire which was submitted to each provider. The responses were studied before meeting with all three on May 5/6 1999.
To avoid any possibility of there being a conflict of interest it was decided to use the investment consulting division of William M Mercer rather than Frank Russell, the trustees’ normal investment advisers. Stuart Gordon and Steve Delo of William M Mercer had two preliminary meetings with Pound before reviewing the issues with the full sub-committee on the morning of May 5. The three candidates were then interviewed over the following two days.
It became apparent early on in the process that, given the small market in the UK of multi-manager providers, the exercise was probably the first by any body of trustees in the UK. Each provider admitted it had never before had to compete with other multi-managers – previous beauty parades had always put them in competition with either balanced or specialist managers.
The recommendation
The result of several hours deliberation was to recommend that the trustees invest the equity element of the fund in the multi-manager vehicles of Northern Trust. The reasons are as follows:
q Global Asset Management was only able to offer a ‘fund of funds’ where an individual investment manager made the decision over which funds to invest in and the proportions thereof. There seemed to be little difference between having an individual manager select stocks, as at present, to an individual selecting funds.
Each process depended upon the judgement of one person and therefore would not give the Trustees the spread of risk that they were seeking. Consequently GAM was not considered an appropriate vehicle.
q Frank Russell has only had a UK equities multi-manager fund since 1996 and the performance achieved over the three years was not as good as had been achieved by Morgan Grenfell:
1998 1997 1996
FT-A All Share 13.8 23.6 16.7
Frank Russell Fund 11.1 21.3 17.4
Morgan Grenfell 12.8 21.7 17.7
By comparison Northern Trust, whose fund was also relatively recent, performed better overall:
Northern Trust 12.6 24.5 20.9
Over the three years Northern Trust UK Equity multi-manager fund returned 19.3% pa against index returns of 17.9% pa.
Interestingly, whereas Frank Russell left its three managers of UK equities with equal shares, thus ensuring style neutrality, Northern Trust took conscious decisions to tilt the fund towards whatever bias it considered appropriate, even though such weighting would always be relatively modest.
Whether this additional intervention added value was not proven but the committee found its level of involvement appealing.
q For overseas equities, Frank Russell had separate multi-manager funds for each region – US equities, Europe, Pacific Basin etc – and would allocate assets to each region in accordance with our initial instructions and rebalance as appropriate. While Northern Trust gave the trustee board this option it also had a global fund managed by three managers with different ‘styles’ .
While the global fund targeted the FT S&P World (ex UK) the managers had freedom to vary the proportions against the index as they read the market with each manager having their own target of beating the index by more than 2%.
Northern Trust’s Global Fund appealed to the committee as it did not feel qualified to make asset allocation decisions and preferred the investment manager to make those decisions on a day-to-day basis.
The performance of the Global Fund over the past three years indicates the system works, with returns of 15.3% compared to the Index of 13.9%. By comparison JP Morgan returns were:
1998 1997
Index 22.3 19.3
Northern Trust 22.9 21.6
JP Morgan 17.08 17.6
The costs
Because Rohm & Haas is paying someone to manage the managers the up-front costs are going to be higher. In theory, this should be more than offset by improved performance.
There will, in addition, be a transition cost estimated between 50 and 100 basis points.
Obviously there will be some direct transfer of stocks but the extent this will happen cannot be determined at this time, hence the cost indicator.
The fee comparisons are:
Present fee structure
Provider Fee (%)
UK equities
£0–10m 0.50
excess over £ 10m 0.25
Current average 0.32
Overseas equities 0.65
Current average 0.42
Northern Trust total fund
£0–20m 0.75
next £30m 0.60
next £50m 0.55
overall cost 0.65
q In cash terms that would amount to an extra £126,500. These costs would come out of the fund and would not be a cost to the company as traditionally all investment management costs have been met by the fund and the actuary makes that assumption when carrying out his triennial valuation.
This article is reproduced from ‘Competitive multi-manager strategies’, published by LLP, details from +44 (0)20 7553 1515