Multi-manager funds sell themselves on picking the right managers at the right time, which investors may lack the time or skill to do themselves. If this type of one-stop-shop investment appeals, there are several options available. The choices differ on fees, flexibility and performance.

The premise of multi-manager investing is that few managers consistently outperform. Selecting the right fund or manager for different markets is a time-consuming and research-intensive process best left to an expert.

The £1.12 billion Witan Investment Trust adopted a multi-manager approach in 2004, having previously been run exclusively by Henderson Global Investors. James Budden, marketing director of Witan Investment Trust, makes the argument for outsourcing fund manager selection, explaining that, ‘It is about finding the best managers from around the world to do the job. You have diversification of absolute risk and diversification of manager risk.’

Finessing your choice
Funds of funds are the most popular choice. They are run by specialist teams at management houses such as Jupiter, New Star, Gartmore, Thames River and Henderson.

Fund-of-funds portfolios can be invested in open-ended funds (OEICs and unit trusts) or closed-ended funds (investment trusts). They will base selection criteria around the track record of the manager, the structure of his incentives and his team. They will also look at the management company, its culture, its team of analysts and its structure.

Funds of funds will tend to be benchmarked against their sector (usually IMA Active Managed, Balanced Managed or Cautious Managed). Groups such as Jupiter aim to generate return from asset allocation and fund selection. When successful, this can deliver higher returns, but can lead to greater volatility of performance. Others believe that asset allocation is not their core skill and focus on fund selection exclusively.

Manager-of-manager portfolios tend to be run by less well-known groups, such as Russell or SEI. Many of these groups have their origins in the US and have tie-ups with UK life companies. That said, Witan and a number of other investment trusts are run along similar lines. But, for the most part, investors are most likely to find these funds as the default selection in their personal pension portfolios or as a potential selection in a life insurance bond.

An institutional approach
This type of multi-manager fund will award segregated mandates to specific managers. The manager of the fund will stipulate how he wants the mandate to be managed and this is often backed up by a lengthy contract. If the manager underperforms, the multi-manager can terminate the contract according to the notice period and allocate the assets to a new manager.

Manager-of-manager funds tend to be more institutional. They will usually focus on a benchmark and have tightly controlled portfolios. For example, a UK allocation might be made up of a growth manager and an income manager and each one will be carefully monitored to check they do not stray from their mandate.

Then, there are hybrid funds, which make use of both approaches. Maia Capital, which manages the multi-manager funds for Resolution Asset Management, uses mostly funds but will allocate segregated mandates when appropriate. For example, it plans to use a segregated mandate for its US exposure because of quirks in the pricing of US funds. Skandia and Axa also use this hybrid approach. Equally, Witan will occasionally make use of funds for its smaller country allocations.

Segregated mandates tend to be cheaper. The managers can negotiate harder on fees because they can promise managers a significant lump sum to run, which is likely to stick for some time. Witan, for example, has a total expense ratio (TER) of around
0.5 per cent. This compares to TERs in the fund-of-funds space of between 1.5 per cent and two per cent. But scale is required to achieve the lower rates for segregated mandates and few fund management houses will offer their top managers at bargain prices.

Cost effects
Alan Thein, a fund manager on L&G’s multi-manager range, says‘Manager-of-manager funds are usually cheaper but, as a fund-of-funds manager, we can also negotiate lower fees. We aim to pay a fair charge for the fund manager. We are not aggressive, but every pound you save is added onto performance at the end, so we ensure the amount we pay a manager can be justified.’

Reduced fees are only useful to the extent that they boost performance over the long term and, in this, funds of funds generally remain ahead. Elliot Farley, analyst at fund-of-funds specialist T. Bailey, believes funds of funds have the edge, despite lower fees for manager-of-manager funds. He says, ‘Over the last five years (to the end of March) in the IMA Global Growth sector, the average manager-of-managers fund has underperformed the average single-manager fund by 29 per cent – the average fund of funds has outperformed the average single-manager fund by 15.4 per cent.’

In practice, many manager-of-manager funds will tend to be very benchmark-driven and tend to congregate around the bottom of the second quartile of funds or top of the third quartile – i.e. the average for the sector. However, in general there appears to be little difference in terms of access to good fund managers between the two styles. Thein also points out that there are some institutional managers that are only available to retail investors through segregated mandates.

Flexible approach 
Investment flexibility is also an important differentiator between the two styles. Farley says, ‘A fund-of-funds manager can usually change an underlying fund within 24 hours if unhappy with performance. With managers of managers, changing a manager can take typically three months.’

Many managers believe their performance is better when they have the security that assets are not going to disappear, leaving them managing redemptions. However, the notice period is flexible.

In general, the two types of approach do not differ significantly in the types of investment included in their portfolios. Sheridan Admans, fund manager at The Share Centre, says they stick to fixed income, equity and property in their portfolios. This is also standard for manager-of-manager funds. If investors are seeking funds that include racier assets, multi-asset funds may provide the answer.

Darius McDermott, managing director of Chelsea Financial Services, says that his group has buy ratings on several fund-of-funds portfolios, including those from Jupiter and New Star, but as yet only one manager-of-manager fund has hit its radar. ‘The Skandia Best Ideas Fund has ten segregated mandates from top fund managers. They have been the only manager-of-managers proposition to achieve our buy recommendation.’

Retail appeal
McDermott adds that funds of funds tend to be investor-friendly products – they are managed by well-known fund groups and contain well-known funds.

However Gavin Haynes, investment director at discretionary management group Whitechurch, says the lower fees on the larger multi-manager investment trusts such as Witan make them more attractive as a one-stop-shop holding than other manager-of-manager products.

His firm tends to use funds to construct their client portfolios and does not believe using segregated portfolios would make a big difference to performance.

Manager-of-manager funds are usually cheaper, but performance has been more benchmark-driven and has failed to excite. The exception would be in the investment trust arena. Conversely, funds of funds will be more expensive, but increased flexibility allows for more aggressive investment strategies, and better performance. However, because there is more variation in returns, investors need to select their managers with greater care.