Pursuing returns while managing risk: the potential benefits of multi-manager portfolios 

Why a multi-manager portfolio?

Multi-manager portfolios are based on the notion that no one investment manager or investment house has 'a monopoly on good ideas' or the necessary expertise across and within all asset classes, investment styles and geographies. In other words, multi-manager portfolios are specifically designed to provide investors with a robust, highly diversified portfolio that's integrated into one solution.

A portfolio can either be fettered or unfettered. A fettered portfolio invests solely in funds run by the wealth or asset manager offering the portfolio, whereas an unfettered multi-manager portfolio invests in funds that are run predominately by third-party investment managers. A multi-manager portfolio can either be a 'fund of funds' vehicle that invests in several funds or a portfolio of 'manager of managers' funds that invests through segregated accounts.

There are many potential advantages to a multi-manager approach, including diversification by asset class, managers, geographies and investment styles. There are additional potential benefits to the ‘manager of manager’ approach, such as access to a broader set of managers, greater transparency and the ability to customise manager guidelines. Investors should be mindful that, potentially, multi-manager solutions may lead to over-diversification, higher fees and increased oversight complexity.

Wealth managers are facing a particularly difficult challenge: how to construct and profitably deliver a discretionary investment management service for private clients and wealthy families against a backdrop of financial market, macroeconomic and political uncertainties. We believe wealth managers need an investment approach that adapts to a changing landscape that is fundamentally transforming how a multi-asset portfolio should be constructed and delivered. We believe this challenge has been purposefully addressed by our multi-manager portfolio approach, designed specifically for wealth managers.

Our multi-manager portfolios combine our market views and investment expertise with our ability to identify and access¹ highly skilled investment managers at very competitive fees. Asset class expected returns and volatility feed into strategic portfolio changes that are quantitatively stress tested, and various risk metrics and probability portfolio success rates are produced. Our range of portfolios encompasses various liquidity and income requirements.

Our current multi-manager portfolios incorporate our latest 'themes and opportunities'.

Building a multi-manager portfolio

1. Our investment beliefs

Integral to our investment process is a set of investment beliefs that form the basis of our portfolio management. We have a long history of working with wealth managers, each of whom has a unique set of objectives that we believe we can help you meet those objectives. We know that successful investing requires clarity of thought. The following are our six core investment beliefs:

1. Each client is unique, with their own personal requirements.
2. Integration of sustainability and responsible investment within a portfolio has a higher probability of creating and preserving long-term investment capital.
3. Genuine diversification is essential to successful investment outcomes, and asset allocation is the most important decision to make.
4. Active management is a skill, and our manager research process can improve the likelihood of identifying skilful managers.
5. Dynamic asset allocation can enhance returns or mitigate risks over the medium term.
6. Monitoring and governance frameworks can be used to improve investment returns by concentrating on evaluating and quantifying costs and improving investment efficiency.

2. Sustainability at our core

Our multi-manager portfolios have incorporated ESG considerations for many years and make a clear distinction between broad-based sustainability and sustainability-themed strategies. ESG integration and stewardship are embedded in the portfolios, both across and within asset classes. Moreover, our multi-manager portfolios are evaluated by our proprietary software, "Analytics for Climate Transition" (ACT), to understand how the financial and physical risk as well as opportunities of transitioning to a low-carbon economy are present in our portfolios. ACT was created to help all types of asset owners plan for adaptation to a 1.5°C (or lower) climate scenario. Our sustainable investment approach, which considers climate change as a systemic risk, is an essential part of how we help wealth managers shape client portfolios. By utilising this approach, we believe wealth managers will be able to preserve and grow their clients’ capital and meet their objectives.

3. Asset allocation framework

In our view, a well-constructed multi-manager portfolio utilises diversification to help enhance outcomes and manage risk. Our liquid multi-manager portfolios are highly diversified across several broad asset classes allocated to many investment managers, all following various and complementing investment styles. When we can incorporate illiquid asset classes, our portfolios are further diversified across hedge funds and private markets. We mitigate one of the core risks within multi-manager portfolios − over-diversification − by allocating to high-conviction managers across different return drivers. We note that the asset class sleeves, asset classes and managers are regularly evaluated, and that they can and do change.

At present, our asset class sleeves include liquidity, downside protection, credit, equity, real assets, inflation-sensitive, diversifying alternatives and private markets.

With regard to downside protection, our core allocation is comprised of global government bonds, including both long- and short-dated bonds. In our view, government bonds remain the best asset class to mitigate ‘growth shock’ risks within a multi-asset portfolio. However, we note that government bonds will not provide protection in a ‘rate shock’ environment, in which persistent above-target inflation has caused interest rates to rise. One way to combat this risk is to diversify portfolios with inflation-sensitive real assets, such as real estate, infrastructure and commodities, which can help mitigate the downside effects of a global inflationary scenario. Furthermore, investors who are less constrained by liquidity requirements could add hedge funds, which have lower sensitivity to traditional asset classes and can dampen overall portfolio volatility through diversification and downside protection.

With respect to credit, our preferred allocation is to absolute return fixed income, emerging market (EM) local currency sovereigns and multi-asset credit (MAC). MAC strategies typically involve investing in a mix of bank loans, high-yield bonds and securitised credit (such as mortgage- and asset-backed securities), with some strategies also engaged in investing in EM debt, distressed debt and convertibles. Portfolios are generally managed in an opportunistic and unconstrained manner, with little or no reference to traditional benchmarks, thereby mitigating the drawbacks associated with benchmark-driven investing.

Within equity, we follow principles-based framework that invests in strategies with underlying return drivers that have academic and empirical support and are diversifying when combined in a portfolio setting. Where possible, we believe equity portfolios should be constructed around a meaningful allocation to actively managed, quality-focused equity strategies (i.e. active quality). We define “quality” strategies as having persistent exposure to companies that display higher-than-average profitability (e.g. ROE, ROA or ROIC). In addition, “active quality” refers to actively managed equity strategies that employ a long-term investment horizon, have sustainability embedded in their investment approach and are positioned for climate transition. Also included are other diversifying factors, such as value and momentum, as well as equity market breadth through allocation to smaller companies and China A shares. Lastly, we incorporate specialised strategies such as low volatility, sustainable themes and impact investing.

Regarding real assets, these include allocations to listed global REITs and sustainable infrastructure within our liquid portfolios and private market allocations to Core/Core+ and Non-Core within our less liquid portfolios. Included within inflation-sensitive are inflation-linked bonds and gold.

Within diversifying assets, we have integrated uncorrelated strategies such as long-only systematic macro and various hedge fund strategies where allowed by liquidity constraints. Where clients allow for increased complexity and have less of a need for liquidity, we can allocate to private markets; this can include investments in private equity, private debt, infrastructure, real estate and sustainable private assets.

4. How we combine managers

Once the portfolio asset allocation has been determined, we seek to populate the asset allocation with our highly rated managers. This is undertaken through the ‘lens’ of a multi-manager portfolio, i.e. identifying highly skilled managers that are lowly correlated and sizing their allocations. This is an unfettered approach as the underlying investment advisers are third-party investment managers. We believe this is key to building a portfolio that is diversified and exhibits the combination of characteristics that can help achieve the portfolio’s overall return objective.

We seek to identify not only managers who have shown an ability to consistently outperform over a market cycle, but when combined, provide diversification that may lead to more consistent alpha over time. As part of this process, we employ a factor-based approach to portfolio construction that helps us to combine managers in a manner that aims to reduce risk and enhance return potential over varying market cycles. We believe this can only be achieved through a continual process of monitoring, evaluation and affirmation of current positioning and thesis.

We are diligent in our selling discipline and incorporate proactive, forward-looking assessments as well as historical indicators. We also stress test our multimanager portfolios with the goal of achieving portfolios that represent what we believe to be the best possible manager combinations.

For example, we might combine the following styles of investment managers: a quality value manager, who seeks to invest in strong, high-quality businesses with sound balance sheets and free cash flow generation, a growth manager, who aims to select stocks with long-term differentiators with the potential to grow earnings faster or longer than the broad market, and a dedicated minimum variance manager, who seeks to maximise return while investing in low-volatility stocks.

There are many potential advantages to populating a portfolio with ‘manager of managers’ funds, including: access to institutional asset managers, and not limited to only registered funds; access to overseas managers who do not have a local fund domicile; access to cheaper institutional fee structures; access to highly rated specialist managers² the universe of potential investment advisers could be much larger than the local domiciled fund; the ability to leverage the scale of ‘manager of managers’ in potential fee negotiations; the ability to remain in the market when switching managers and potentially avoid a taxable event³ greater transparency with trades in real time and the ability to identify style shifts or mandate breaches; enhanced control with the ability to specify ESG objectives; and, lastly, the ‘manager of managers’ setup facilitates strong oversight.

5. Active management is a skill

We believe that active management is a skill and, as evidenced by our value-add analysis, our that manager research process can help improve the likelihood of identifying skilful managers. The characteristics and approaches of skilled managers may set them apart from the average. These attributes may include a better understanding of behavioural factors than a typical market participant, the willingness and ability to take a longer-term view, and the ability to see the big picture or demonstrate the ability to "join the dots". There are different degrees of market efficiency, and it is important to determine which markets possess sufficient potential for alpha generation. Skilled managers are more likely to add value in less efficient markets. Active managers who have high conviction are more likely to deliver meaningful alpha after fees.

While we believe we are able to identify active managers, we also include components of passive management within our multi-manager portfolios. This approach allows for a focus of the active risk budget on asset classes that have a higher probability of outperformance.

6. Twelve actions for better governance

Every wealth manager should evaluate the quality of their investment operations and the implementation of investments, regardless of their size or complexity. Inefficiencies, poor implementation and lapses of internal controls could lead to eroding returns, exposing their clients to unwanted risks and potential losses. We believe there are 12 fundamental steps that wealth managers can take to improve their governance. These can help wealth managers stay on top of what's happening today and be ahead of the curve. There are certain tasks that may need more frequent attention, and some may require extensive operational resources, but all are necessary to establishing a framework that makes wealth managers feel confident about meeting their objectives and remaining in control. Our multi-manager portfolios are built utilising our 12-step governance framework: 

1. objective setting,
2. investment strategy design,
3. strategy implementation
4. portfolio design
5. asset allocation
6. manager research
7. manager selection
8. strategy/portfolio implementation
9. rebalancing and cash flow management
10. regulatory compliance
11. monitoring and risk management
12. governance and reporting.

Why wealth managers collaborate with Mercer

With over 40 years of experience in advising and managing investments, we have extensive expertise in helping to protect and grow our clients' assets, access illiquid asset classes⁴, help mitigate risk, integrate ESG and create climate resilient portfolios, and help to reduce overall costs⁵. Whatever your objective, our specialists can help.

^{1. Mercer cannot guarantee access to opportunities. Access is at the discretion of the investment manager.}

^{2. Mercer cannot guarantee access to opportunities. Access is at the discretion of the investment manager.}

^{3. Mercer does not provide tax or legal advice. You should contact your tax adviser, accountant and/or attorney before making any decisions with tax or legal implications.} 

^{4. Mercer cannot guarantee access to opportunities. Access is at the discretion of the investment manager.}

^{5. Savings cannot be guaranteed.}