In recent years, multi-manager platforms have emerged as cost-effective solutions that deliver diversified returns across multiple asset classes. According to Morningstar, multi-manager solutions grew from $585 billion in 2014 to $704 billion in 2017, increasing 20% in three years. These solutions include the expansion of open architecture platforms that leverage the expertise of internal and external portfolio managers to deliver holistic portfolios through a single platform.
The potential for multi-manager platforms is significant, but so are the associated investment-related and operational challenges for asset managers. Building a scalable open architecture platform requires a solid operational framework backed by robust technology that can accommodate the complexities of different strategies, currencies, and securities – not to mention risks and liquidity profiles – that make up these funds.
Here, we discuss the rise of multi-manager platforms, their operational challenges, and the functions needed to support them.
Multi-manager nuts and bolts
The premise of multi-manager platforms is simple: they are a collection of different portfolio managers (who specialize in different asset classes), organized by one overarching manager (the asset manager). The asset manager establishes an umbrella vehicle with sub-funds that invest in specific asset classes and strategies (e.g. large cap equity, high yield fixed income, alternatives, etc.), and is responsible for the selection and allocation of capital to the underlying managers within the portfolio. The asset manager can select the best portfolio managers in a given category, eliminating the need to build in-house capabilities across any of the asset classes it invests in.
The multi-manager model, compared to a traditional fund of funds (FoF) structure, provides the opportunity for asset managers to customize portfolios at a lower cost than investing in the pooled investment vehicles of their chosen portfolio managers. On the other hand, the asset manager will need sufficient scale to cover the operational costs of establishing the platform.
While often confused, multi-manager funds are not the same as pure multi-asset funds, in which the asset manager invests in a proprietary collection of different asset classes. For instance, a multi-asset fund might invest in 60% equities and 40% fixed-income, with security selection and asset allocation coming from the fund’s portfolio manager. Meanwhile, in a multi-manager fund, the asset manager selects individual fund managers (sub-advisors) to manage assets in their specialized areas, in effect delegating security selection to the individual sub-advisors.
To take it one step further, in multi-manager structures, an individual sub-fund can be split across multiple sub-advisors. This additional layer of division allows for a greater diversification within a single investment strategy. For example, a US equities sub-fund can be allocated across three individual sub-advisors each focusing on a sub investment strategy within the overarching US equity strategy (US large cap, mid cap, and small cap). Managers can apply the same logic for sector or regional based diversification needs across equities, fixed income, and less liquid strategies.
The multi-manager model may also appeal to sub-advisors because it allows them to focus on their core responsibility of portfolio management, while still receiving the benefits of a relatively captive flow of assets via the platform sponsor. According to Cerulli, 54% of sub-advisors believe multi-managed mutual funds will be a significant opportunity for growth over the next three years.
Demand for portfolio “solutions”
In recent years, there has been a pronounced shift of assets from commission-based to fee-based advisory accounts. While the transformation has been ongoing, the now defunct DOL fiduciary rule in the US helped accelerate this trend as advisors sought to comply. According to a recent SEI study, 52% percent of advisors have changed their fee structure within the past four years.1 The implementation of MiFID II is having a similar effect in Europe. Prompted by new fee models, many financial advisor firms are seeking asset managers to create bespoke, fee-friendly portfolio solutions that are tailored to their specific needs.
For advisory firms, multi-manager platforms can be an appealing way to simplify trading and lower costs. Some firms have been able to decrease overhead costs by wrapping servicing, trading, and managing fund fees into one fee group, which is collected by the financial advisor. The multi-manager fund structure can also give advisory firms access to top portfolio managers. By employing those portfolio managers through segregated mandates, instead of purchasing their mutual funds, multi-manager platforms can potentially negotiate a better deal on fees.
Global managers have found viable distribution opportunities for multi-manager platforms. In the US for example, some multi-manager platforms serve as portfolio building blocks for in-house advisory channels. For instance, Edward Jones, Brinker Capital, Charles Schwab, and Morgan Stanley have all created multi-manager platforms for their network of advisors.
For global distribution, firms are establishing these vehicles in the cross-border domiciles of Ireland, Luxembourg, or Cayman. Both retail and institutional channels are adopting multi-manager solutions and firms are deploying master feeder fund structures for specific countries and investor types. Multi-manager platforms may also play an increasing role in the emerging robo-advisor space. Today, robo-advisor platforms generally offer investors diversified portfolios composed of low-cost index tracking funds or exchange traded funds (ETFs). But as robo-platforms evolve, there may be greater emphasis on exceeding benchmark returns through active management. Since multi-manager platforms are often designed to generate alpha, it stands to reason they may become more prominent on robo-advisor platforms.
The operational complexity and associated oversight needs for a multi-manager model are often directly correlated to the number of underlying managers (sub-advisors) plugged into the platform. It’s essential for asset managers to have a flexible infrastructure that not only connects the platform directly to the sub-advisor and custodians, but efficiently translates data into actionable insights and analytics. This is especially important when executing tasks such as client reporting, derivatives processing, and regulatory reporting. In order to streamline information sources, a holistic data management strategy – one that includes data aggregation, translation, and delivery – should be the cornerstone of the multi-manager operating model.
Another consideration for multi-manager platforms is having a robust change management process that can seamlessly transition sub-advisors in and out. It is not uncommon to see platform sponsors change sub-advisors within a multi-manager structure, however it is critical to be able to do so without interrupting daily operations or impacting the fund’s performance.
Cash management and Foreign Exchange (FX)
Cash management is a critical component of the operating model. The platform manager can take an active approach to the allocation of capital to underlying managers, while other platform managers prefer to take a rules-based approach that passively allocates capital through an algorithm. Additionally, many investment managers within the platform prefer to receive cash allocations in bulk, rather than in small amounts that trickle in with subscriptions to the fund. Shareholder redemptions can also raise cash management decisions, as the manager must determine whether to raise cash from one sleeve, or across the funds, requiring each sub-manager to have a pro-rata slice.
In Europe, share class currency hedging is a popular tool for broadening distribution across multiple markets. The multi- manager structure adds a degree of complexity to the hedging process as currency exposures can be fragmented across multiple portfolios. A well designed and implemented hedging program will mitigate this risk.
Data management and compliance
Pre- and post-trade risk and compliance may be difficult to track across multiple investment managers. Having a well-defined Investment Management Agreement (IMA) will help maintain control over the managers, but issues can arise when aggregating exposures across multiple investment managers within the same individual sub-fund. The multi-manager platform must have the capability to monitor portfolio risk and fund compliance levels across multiple managers.
Though the compliance monitoring functions are largely the same for ’40 Act single-manager funds, the compliance oversight of multiple sub-advisors can present an added layer of complexity. Beyond monitoring the investment performance of each sub-advisor, platform managers must also conduct rigorous due diligence and risk management processes for the sub-advisory managers and the firms they work for. Since platform managers need to obtain board approval for any advisor contract on an annual basis – otherwise known as the 15(c) process under the ‘40 Act – it’s essential for them to understand a sub-advisory firm’s succession planning protocols, compliance programs, and overall profitability.
For asset managers, operating a multi-manager solution presents a multitude of technical and infrastructure challenges.
The most successful multi-manager models are built on a system that can support an array of complex strategies, currencies, and securities, including those that will arise in the future. Through our experience creating and servicing products, we believe the multi-manager operating model should include:
- A flexible, open architecture that can efficiently onboard managers, markets, and counterparties
- A robust data management strategy that encompasses day-to-day operations, regulatory, compliance, and client reporting
- A fluid, repeatable process for cash and FX management
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1 SEI: Fees at a Crossroads Revisted: Closing the Gap Between Price and Value, 2018