The role of multi-managers within asset allocation
When asked the question of what role multi-managers should play within the asset allocation requirements of plan sponsors, it is worthwhile considering the current usual arrangements.
The traditional mechanism usually involves a sequential and linear relationship between the plan sponsor, the appointed actuarial and benefits consultancy and the appointed fund manager, or managers. Typically, the consultant will conduct the asset/liability modelling (ALM) study. Essentially, this will determine the current value of the fund, the projected future cash flows from scheme members’ contributions, and the existing and projected future payments from the scheme to its retirees.
From this point it is, historically at least, a natural further step for the consultant to determine the asset allocation that best matches the ALM. The consultant will determine the most suitable mix between, typically, equities and bonds, the usual asset classes which are considered (the largest schemes will also usually hold an element of property).
The understanding is that the equities component generates growth, but includes an income element, and the bond component generates income, provides some capital preservation and a degree of non-correlation with the equities component. Once the asset allocation is determined, a search is conducted to find a suitable fund manager, or managers, who then implement the prescribed allocation.
Nowadays, following a number of pieces of widely-published and accepted academic research, there is little doubt about the impact of asset allocation. Indeed, asset allocation is responsible for over 90% of investment performance1.
It is important to get it right. So should equities and bonds, and maybe property, be the only asset classes considered?
The spectrum of asset classes that is available nowadays, in an accessible (in other words, securitised) form, range from cash to short-dated bonds, domestic government bonds, corporate bonds, domestic equities, foreign equities, foreign bonds, emerging market debt, property funds, market-neutral hedge funds, equity long/short hedge funds (both un-leveraged and leveraged), financial futures and CTA funds, and private equity funds.
The relevant point to note is that asset classes should be defined by the differences in their expected response to economic conditions, and by their degrees of correlation with one another. After all, little diversification will be achieved if the chosen asset classes show positive correlation with each other – as has been the case between UK equities and foreign (major-market) equities in recent years.
The trouble is that few, if any, traditional investment managers have the ability/desire to deal with such a vast range of asset classes. Neither do many actuarial and benefits consultancies have the ability or means to address such a range of asset classes. How many pension schemes, particularly those below say, e200m, hold anything other than domestic and foreign equities, domestic bonds, perhaps a dash of property, and cash? The answer is of course not many. Does this help to explain the disastrous state of UK pension scheme asset allocation in recent years?
The multi-manager, in contrast to the traditional investment manager and the actuarial consultants is, or should be, in a position to survey all asset class opportunities, as well as to research and identify suitable managers within each class. So shouldn’t the multi-manager be playing a greater role than simply implementing a prescribed asset allocation? Could the multi-manager be involved in actually formulating the asset allocation for the pension scheme?
I believe that the multi-manager’s true calling lies beyond simple manager diversification, the original and traditional raison d’être. The modern multi-manager business, if it is to be truly effective, must posess sufficient research resources and the proper complement of individual’s skills and experience sets to do more. Given sufficient liability information from the pension scheme’s actuary, the multi-manager – of all the professionals normally involved (actuaries, trustees, senior company management) – may actually be in the prime position to determine the strategic asset allocation for the pension fund.
At RMB MultiManagers, we have built our resources specifically to create this capability. We have decided not to merely present investment management products to a pension fund, which may only have limited applicability to the fund’s specific needs. Instead, our preferred approach is to work directly with the plan sponsor and its consultants in order to identify the investment objectives and the desired targets for both risk and return, and gain the necessary liability information.
We will determine what we consider to be the most appropriate combination of traditional and alternative asset classes and produce a proposal for the construction of a bespoke segregated portfolio designed specifically for that individual plan sponsor. Consulting with the plan sponsor and its consultants we can then fine-tune the portfolio’s design as necessary before proceeding to agreement and implementation.
So what makes us believe that we can occupy the hallowed ground of strategic asset allocation, so traditionally seen as the droit de naissance of the actuary?
First, as a fully-resourced multi-manager firm, we can access
management expertise not merely
in bonds and equities, but in all
traditional and alternative asset classes in any market in the world. We are not constrained by in-house
capabilities because we outsource for all the best management expertise available in the market, which will include some of the more esoteric asset classes and investment
instruments that are often denied
to all but the very largest pension plans.
Second, with such a broad oversight of all of today’s available asset classes we have always seen it clearly as our job responsibility to take into account fully how these different asset classes are expected to behave in different market conditions, in
different economic conditions and in different geographies. And so we set out to construct efficient portfolios
by combining asset classes that vary in response to the forces that drive markets.
And why should we think we are well-positioned to implement the asset allocation?
It is because, as a multi-manager, we do not need to succumb to the diktat of any single investment
philosophy. We do not need to persist with an active fund management philosophy when our research informs us that 88% of UK gilt fund managers underperform the UK gilt index. We can afford to recognise that there truly is an inverse
relationship between asset pricing and the success of active management2 – so we can appoint a passive manager to run the money in the super-efficient UK and US bond markets, for instance. We would rather expend the risk budget (that we have already agreed with the sponsor and their consultant) on seeking active managers to generate excess returns from less efficient markets. And neither must we subscribe to any self-imposed doctrine of being either a growth or a value manager. The fact is that no single investment style is going to generate outperformance through all the different market cycles. In the knowledge of this fact, we can target those specific styles that will be successful within each asset class and region and appoint managers who are the most skilful exponents of those styles.
Neither do we need to feel any
pressure to have to advocate either long-only, traditional strategies, or to uphold the cause of alternative
strategies alone, for we manage both. The significance of alternative investing strategies lies in their ability to diversify overall portfolio risks, and also as a tool for accurately targeting the pension fund’s specific risk and return requirements. Wherever required, we will blend both into the pension fund.
Can a pension plan sponsor truly find all these attributes and abilities
in a single service provider, who
provides the single point of contact and takes full accountability for asset allocation, portfolio construction
and management, as well as fund manager selection, monitoring and replacement? Yes, this is what the modern, fully-equipped and organised multi-manager can and does provide, increasingly, to the pension fund marketplace.
Jeremy Beswick is head of business development RMB MultiManagers in London and is a director of the Association of Institutional Multi-Manager Investing
1 G P Brinson, B D Singer,
G L Beebower, ‘Determinants of Portfolio Performance II: An Update’, in Financial Analyst Journal, May-June 1991
2 David Swenson, ‘Pioneering Portfolio Management’, Simon and Schuster, 2000