13th February 2006

"Multi-managers are on the rise"

By AMIN RAJAN

"Life is what happens to you while you're busy making other plans," ruminated John Lennon upon the break-up of the Beatles. Yes, the bulls are back, bonuses are sky-rocketing and mergers and acquisitions are racing up the corporate agenda. Yet, below the surface, it is not business as usual.

Multi-manager mandates have rocketed three-fold since 1999 and are set to grow by another 50 per cent by the end of 2009, notching up a compound rate of 14 per cent over the period, according to data from Boston-based Cerulli Associates.

They also show that the popular perception of an enclave inhabited by early pure-play pioneers such as Russell Investment Group and SEI Investments is increasingly off the mark. New players account for about a third of the worldwide multi-manager assets of Dollars 1,100bn (Pounds 632bn, Euros 920bn).

The mandates herald the arrival of lean production methods, invented by the car maker Toyota in the 1980s. It created assembly platforms that relied on components manufactured by external specialists, working seamlessly with their immediate client in all areas.

As a result, Toyota halved its unit costs and produced twice as many models on a single assembly line, achieving scale at the assembly end and flexibility at the craft end. Green shoots of something similar are evident in hot pursuit of alpha, skills-based high returns in fund management.

"Ours is an intellectual partnership based on extensive dialogue and a long-term relationship that does not involve an equity stake. It involves arms-length economics to safeguard client interests. We choose managers on the basis of teams and replicability, we aim to minimise star culture," says Karl Dasher, chief investment officer of SEI Investments.

"Our goals are high returns and low risks. Although independent, our end-managers are an extension of us, given our expertise across a large chunk of the investment value chain. Being part of our platform gives them credence."

Multi-manager platforms are attracting interest not only from clients of all hues - institutional, retail, high net worth; they are also proving a popular diversification route for fund managers, distributors and pension consultants alike. Businesses as diverse as Fidelity, Scottish Widows, Banca Populare and Mercer Consulting are boldly going where they have not been before.

Frederic Jolly, chief executive of Russell Investment Group, says: "By selecting end-managers from a large universe, we avoid putting all our eggs in one basket. So our clients enjoy all the benefits that come with critical mass. The resulting growth has enabled us to diversify into a new family of high-tracking alpha funds.

"Unless multi-manager firms deliver premier quality, it is hard to justify their existence. They need critical mass to support a huge infrastructure of quality assurance and top talent. We have zero bias towards hiring cheap end-managers."

The implicit proposition is seductive: "We diversify your assets among the best producers, so if we fail, that's only because the best have failed." No wonder the hunt for best-of-breed products has intensified worldwide, pushing numerous impediments to the fore.

To start with, for mainstream fund managers and banks with in-house manufacturing capability, the issue of conflict of interest is ever present without foolproof fire walls. Many fund managers do not have elaborate infrastructure of cash flow management. Finally, end-managers prefer to work with a specialist assembler than a potential competitor.

But that's not all. Capacity and scaleability are limited among end-managers, two-thirds of whom are independent boutiques. They face challenges similar to hedge fund managers (see figure), who have three clear scale points and a series of dilemmas to resolve, as highlighted in the latest Create-KPMG report*.

Likewise, the long-only alpha boutique managers typically see theirs as a lifestyle business, where growth creates bureaucracy and dilutes their craft. Paradoxically, a sustainable business requires scale but the resulting complexity in the business model can kill alpha.

Glyn Jones, chief executive of Thames River, says: "As a concept, the multi-manager platform is attractive. But finding sufficient capacity at the top quality end-managers is hard. As multi-managers get bigger, the risk is they can't find scaleable alpha and end up as closet trackers with returns reverting to mean.

"As alpha is not infinitely scalable, top quality managers have to decide how to price and ration scarce capacity. Going to end users may prove better than intermediary relationships."

Thus, the headlong growth in multi-manager platforms has inherent limits. It is likely that the industry will bifurcate over time between pure play firms, and hybrids such as ABN Amro Asset Management and Lehman Brothers Asset Management.

Other structures are equally likely.

Prof Amin Rajan is the chief executive of Create, a research consultancy

* available from amin.rajan@create-research.co.uk.