Selectors pick best of fund multitude

There are two ways to approach multi-manager funds: the fund of funds route or via managers of managers. Simon Hildrey writes on the upsides and downsides of both. The past three years have shown that picking successful funds is not as easy as many investors thought. Those that rushed into growth and technology funds in the spring of 2000 now face substantial losses. Over the past three years, for example, the offshore Aberdeen Global Technology fund has lost 76.57 per cent of investors’ money. This compares with a sector average loss of 69.66 per cent. Yet over the same time period, the asset manager’s emerging market debt fund, Aberdeen Sovereign High Yield, has returned +88.03 per cent against a sector average of +58.54. But, in April 2000, how many investors would have decided to buy an emerging market debt fund rather than a technology fund? It is not only asset allocation decisions that investors have found difficult over the past three years. Picking individual funds can also prove problematic for a variety of reasons. If managers switch investment houses, the performance of their fund, its style and its risk return profile can change significantly. Hard work It can be difficult for investors to keep track of the movement of managers, particularly if they have a diversified portfolio of more than 10 funds. Providers of multi-manager funds say that investors do not have the time or resources to track changes in fund manager personnel in order to decide whether to move with the manager, stay with their original fund or select a different fund altogether. Furthermore, the style or risk profile of funds can alter even without a change of manager. Consolidation of asset managers is another common factor that can lead to a change in the investment approach of funds. There are two main approaches to managing multi-manager funds:

• Funds of funds invest directly in the pre-existing retail funds of asset managers. Examples are Fidelity Special Situations or Gartmore European Growth. Providers of funds of funds argue that this approach allows them to move in and out of vehicles easily since retail pooled products offer high levels of liquidity.
• Manager of managers funds, however, draw up specific mandates for each asset manager to follow on a segregated basis. The advantage of this approach, favoured by the likes of SEI, Russell and Northern Trust, is that the underlying asset managers are only running money for the manager of managers, so performance of the mandate is not affected by other investors redeeming their money. The mandate is managed according to the particular wishes of the manager of managers so it can be a more effective way of diversifying the overall multi-manager portfolio. As a result, the manager of managers will know the investment approach and holdings of all the underlying managers. Another advantage of the manager of managers approach is that they can invest with institutional asset managers normally inaccessible to retail investors in Europe, such as Wellington and Blackrock. Diversified porfolio Providers also argue that manager of managers provide investors with a diversified portfolio of funds, allowing them to spread their risk across fund houses, asset classes and regions. Through the large number of assets under management, multi-managers claim they can negotiate cheap fees with investment houses. According to the theory, managers of managers can access the best performing fund groups in each class and region and blend them to produce enhanced returns. The downside to manager of manager funds is that as the only investor in the segregated account, it is not as easy for a multi-manager to switch from one underlying manager to another. A hybrid form of fund has recently been added to the mix. Skandia Investment Management, the asset management arm of insurer Skandia, has launched multi-manager portfolios that combine the fund of funds and manager of managers approaches to try to capture the advantages of both. A key point to note is the distinction between fettered and unfettered fund of funds. Fettered products only invest in funds run by the same asset management group as the multi-manager fund. Unfettered products are not obliged to invest solely in internal funds. Over the past five years, there has been a proliferation of multi-manager funds across Europe, of which fund of funds are far more prevalent than manager of managers. There are a number of ways in which investors choose between this vast range. The key differentiators are:
• Performance
• Fees
• Selection and monitoring of underlying fund managers
• Construction of the underlying portfolios. Laurent Gorgemans, Fortis Laurent Gorgemans, head of fund of funds business at Fortis Investment Management in Luxembourg, says the most important factors he looks at when choosing products are the multi-manager’s research processes and the performance of the vehicle. “Multi-manager funds have become harder to manage over the past few years because of the growth in the number of funds. In Europe, you have to choose between about 25,000 funds now,” he says. “We use both quantitative and qualitative approaches to selecting underlying funds and we use quantitative tools to screen the initial universe of 25,000 products.” Fortis uses net asset value as another filter. “As we cannot invest more than 10 per cent of the portfolio in one fund, we strip out any funds with assets under €100m,” explains Mr Gorgemans. “During the quantitative screening we divide the funds into asset classes and investment styles. If we did not separate them into styles and asset classes, we would only choose value managers on the basis of their performance against growth funds over the past three years.” Product scrutiny The universe of funds is reduced further by analysing each product’s information ratio, the consistency of the information ratio, tracking error, number of positive months of returns and the number of drawdown months. Through these analyses, Fortis draws up a list of about 500 funds. The qualitative process involves sending questionnaires to asset managers, as well as visiting managers and teams in their offices. “We look at the risk controls, philosophy, organisation and turnover of employees. We then give internal ratings to the funds in each asset allocation, region and style,” says Mr Gorgemans. Fortis selects what it believes are the best funds in each asset class, region and style for its multi-manager portfolios. The weightings are dependent on Fortis’s current asset allocation view. Mr Gorgemans argues that by constructing portfolios in this way, Fortis, which has three fund of funds analysts, can blend together a portfolio of complementary funds. Commerzbank’s German retail funds subsidiary Adig has an innovative approach to building funds of funds. The job is handled by its asset management arm, Cominvest Asset Management. Thomas Romig, manager of fund of funds at Cominvest, explains that when looking at past performance the firm analyses discrete periods. Rather than analysing the past three or five years, as is typical practice, Cominvest looks at each year within this time period. Thomas Romig, Cominvest Once the funds have been chosen, Cominvest places particular emphasis on continuous monitoring. “We establish stop loss points for funds”, says Mr Romig. “If over six months a fund underperforms its benchmark or sector by a pre-determined amount, such as 6 per cent, we will seriously review it. In about 70 per cent of cases where funds reach their stop loss points we will redeem our money. “The stop-loss point varies, depending on the tracking error of the fund and therefore how aggressive it is. We keep in regular touch with fund managers. Even if they outperform. We like to know where the outperformance has come from.” Mr Romig says that at least 90 per cent of ADIG portfolios comprise external funds. He claims that for other multi-manager providers as much as 40 per cent of their portfolios may consist of internal managers. Allocation decisions DekaBank’s slant on funds of funds is to concentrate on asset allocation. Steffan Selbach, manager of fund of funds at the bank, which is owned by the German savings banks association, the Sparkassen, says that “about 70 to 80 per cent of success from fund of funds comes from asset allocation decisions, with only about 20 to 30 per cent from picking good fund managers.” Steffann Selbach, DekaBank In calculating asset allocation for fund of funds, Mr Selbach says DekaBank looks at the gross domestic product of different countries, inflation, economic growth, fiscal growth, monetary policy and earnings growth. “There is a weekly meeting to analyse our asset allocation weightings. A separate department of 15 people analyses a universe of between 2000 and 2500 funds. The first screening looks at the ratings given by Standard & Poor’s, Morningstar and Ferri Trust. If 25 per cent of an asset manager’s funds are in the top two deciles of ratings by these three firms, DekaBank will look at the manager’s whole range of funds. “We use this process to determine whether an asset manager has a strong investment process. If only one fund has performed well this could be down to an individual manager or luck,” says Mr Selback. Performance not talk Another differentiating factor, he argues, is the fact that DekaBank is not interested in talking to fund managers. “Managers are trying to sell us their funds. We prefer to look at the funds’ risk adjusted performance and then give them a rating. “We analyse the underlying holdings in all the funds to ensure they complement each other. Only by looking at holdings can you be sure funds in your portfolio are complementary. For example, if every fund had a stake in Microsoft, you would have a problem. We look at the funds’ exposures to stocks, sectors and countries.” The final selection criteria, he reveals, is a study of investment styles. DekaBank assesses each fund’s exposure to regions, sectors, large and small caps and tracking error. Funds are grouped according to their style characterisation. “If the asset allocation committee decides we need to increase our exposure to US large cap funds with a large tracking error, we have eight funds we can choose from that have met our selection criteria.” So multi-manager funds can provide investors with portfolios diversified across managers, asset classes and regions, as well as the potential to invest in the best funds available. In selecting multi-manager funds, investors need to consider whether they want to take the fund of funds or manager of managers approach. They must consider risk-adjusted performance, fees charged, research process used, resources to research funds or managers and the monitoring of underlying portfolios.