Talking trust: how fund selectors should approach multi-asset
This essay appeared in Citywire Selector on March 21, 2016.
Against expectations, fund investors are more trusting of fund managers than they were before 2009. This trust is not evenly distributed and seemingly needs to be earned.
On the one end of the active management spectrum, where apparently little value for fees is expected, passive access to specialised asset classes is raging. Though there are certainly exceptional stock investors who continue to stomp benchmarks and gather assets, they have become the exception.
Fund investors don’t trust managers’ ability to provide value for the fees sought in narrow categories. Stick too close to the benchmark and you will be marked with the big CI (‘closet indexer’).
On the other, high degree of investment freedom products like broadly defined multi-asset, alternative and unconstrained fixed income funds have gathered the vast majority of attention and investor money. The middle, (not quite active enough…perhaps a closet indexer) is a precarious spot to be standing.
Trust is looking more like an ‘all, or not at all’ proposition. Low interest rates and volatile markets have driven much of the growth in high degree of investment freedom strategies. The current environment was born out of a crisis.
The resulting uncertainty has led to the recognition of the broader value that fund managers are able to deliver. This has driven fund investors to diversify not only positioning in portfolios – that is the exposure to asset classes, currencies, geographies – but also to increasingly diversify at the level of the decision makers driving those positions.
The task of fund investors in this environment is less about picking the best manager in a particular asset class as it is about picking a manager who can simultaneously pick the right asset class and the right time and the securities within it to produce a desired outcome. That’s the trick.
Getting the most of ‘go anywhere’
This brings us to a point of friction with which the industry must now contend. Fund investors are allocating to highly active managers able to go many ways if not ‘go anywhere’.
There is a growing risk that end-client portfolios are being constructed as a residual of the decision being made in the funds being used. Include three or four highly flexible strategies in a client portfolio and it is ultimately those underlying fund managers who determine the total portfolio asset allocation.
What happens when the three managers hired to manage fixed income managers all decide to use their ability to allocate up to 20% in equities, 20% in convertibles and the high yield exposure goes to 40%? Fixed income isn’t what it used to be, or what it was expected to be by end-investors.
To the extent that these decisions are in line with or conflict with the intended strategic asset allocation should be a core concern. The construct of end-client portfolios is being determined, to greater and lesser extents, by the flexibility of underlying managers’ decision-making.
This fact leads investors into one of two directions: either utilise cheap access vehicles to fill the intended strategic asset allocation, thereby ensuring the consistency with intended positioning or figure out ways to get a robust understanding and full control of the moving parts within client portfolio.
The intermediaries who serve end-client relationships ultimately have no other choice. Getting our arms around this as an industry will be central to ensuring that we are meeting our duty to investors and that we are able to deliver to our potential.
Future of multi-asset
What does the future hold for ‘multi-asset’ and the broad range of highly flexible funds that have seen massive growth over the last several years? Will this prove to be another passing product trend or is there something more substantial beneath the surface?
Take into consideration the shifting relationships between ‘distributor’ banks and ‘manufacturer’ fund companies. Just as the strategic framework for ‘best in class’ selection of specialist funds in an open-architecture environment was quickly adopted as the norm, a new framework of engagement may now be taking shape.
While the investment capabilities of many managers are expanding to meet the new reality, the delivery of those capabilities is stuck in an exhausted distribution model. Innovation into the next major phase of industry development will be driven by advancements in delivery as well as investment capabilities.
A combined formula will align the interests of parties along the value chain to ultimately provide the best possible solution for end-investors. Pre-packaged ‘product’ delivery will not suffice. Sub-advisory engagements through separate accounts will likely drive transparency and product innovation. This is just the start.
In order for the strong efforts of the regulators to ensure the benefit accrues to the end investor, there must be strong cooperation on the part of those who now, more often than ever, appear as competitors.
All incentive structures, including commercial ones, need to be in place as to the reasons to cooperate and ensure that it is ultimately the investors whose money is entrusted have their interests and objective met.
In response to a crisis, or during periods of heightened competition and/or regulatory scrutiny, the investment management industry finds itself in a position requiring competitive cooperation.
We find ourselves in such a situation today. This industry is ripe for an innovation – all of the ingredients for a major long-term cycle are in place.