Control Freaks

The biggest fund managers in the world are doubling down on multi-asset. Are asset owners willing to cede control?


The biggest fund managers in the world are doubling down
on multi-asset. Are asset owners willing to cede control?

Reported by Nick Reeve Illustration by John Hendrix

Relax, you’re working too hard. Let someone else make that decision for you. Delegate manager selection for once.

In fact, why not delegate it permanently?

Some of the world’s biggest asset managers are ready and more than willing to take on the challenge via multi-asset mandates.

At the start of January, BlackRock—the biggest of them all—reshuffled its leadership with crossbucket products at the heart of the new structure.

“Our multi-asset strategies business represents one of the firm’s leading opportunities for growth,” wrote CEO Larry Fink and President Rob Kapito in a note to the staff. “To build on the strong momentum in this business, we are going to continue to build the firm’s capabilities across the platform, create a more cohesive asset allocation message, and work with our distribution partners to deliver multi-asset solutions for clients anywhere in the world.”

Target-date funds and impact-investing staff were brought under the multi-asset umbrella, amid a number of promotions and internal transfers.

Also in January, Russell Investments appointed Vernon Barback as president and tasked him with sharpening up the company’s internal systems and positioning the multi-asset business for the “tremendous growth opportunities that lie ahead,” according to CEO Len Brennan.

Fund flow data show the wind blowing strongly in favor of multi-asset funds. According to Morningstar, “allocation funds” attracted record inflows of €147.9 billion ($163.2 billion) during 2015, up 8.6% from 2014. Lipper, which classifies mutual funds differently, recorded inflows into “mixed-asset” strategies of €95.4 billion, making it the best-selling category of the year.

One such product, Standard Life Investments’ Global Absolute Return Strategies fund, brought in more than €1 billion in December alone through vehicles domiciled in Luxembourg and the UK, according to Lipper.

These giant asset management groups don’t just want a share of the money in your portfolio. They want to do what they like with it.

The question is, do you trust them?

“It is advisable for one that he shall divide his money in three parts, one of which he shall invest in real estate, one of which in business, and the third part to remain always in his hands (as it may happen that he will need cash for a profitable transaction).”

So says the Talmud. The concepts of diversification and multi-asset investing quite literally go back millennia.

“Wouldn’t your trustees ask why you’re giving up part of your day job?”

Yet the Talmud has very little to say on who should be ultimately responsible for that decision. (No word on whether collateralized debt obligations are kosher either, but that’s another matter.)

When I began asking asset owners whether they would be happy to cede control to asset managers, I expected a fairly short answer rejecting the notion out of hand. And we got one.

Stefan Beiner, CIO of Switzerland’s CHF38 billion ($38.4 billion) Publica pension, says selecting the “building blocks” of a portfolio “should be done by the asset owner, not a third party, or you’re moving towards fiduciary management.”

“I strongly believe that [asset allocation] should be the core competency of an asset owner, especially above a certain level of assets,” he adds.

At Publica, Beiner prioritizes asset-liability management (ALM) above almost everything else. To do this in a dynamic way, he explains, it is important to retain control over the building blocks: the equity funds, bond funds, and other asset classes that make up the pension’s portfolio.

“Within our risk budget, we try to optimize the risk factors we’d like to capture,” Beiner says. “We implement a dynamic ALM strategy and we think pretty hard about what the different building blocks are and how much to put with each one.”

While Beiner is happy to outsource, for example, 5% to an emerging-market equity manager, he would not be comfortable also giving the same manager responsibility for a 5% allocation to emerging market debt and giving them free rein to allocate between the two asset classes. “These decisions should be made internally,” he says.

Stefan Dunatov, CIO of the UK’s Coal Pension Trustees answers our question with two of his own. “Why would you contract that out? Wouldn’t your trustees ask why you’re giving up part of your day job?”

Those who do delegate, Dunatov warns, run the risk of losing control not only of assets but also of their entire approach and investment culture.

Turn to the consultants, and you get a similar response.

Art by John HendrixArt by John Hendrix lightbox-button “Asset managers saw the opportunity and the assets started growing quickly without necessarily the same quick growth in skill,” says Luba Nikulina, global head of manager research at Willis Towers Watson. “It’s relatively easy to build something specialized, but navigating across a variety of strategies and having those exposures is really hard. You end up with products that are not structured well.”

Nikulina explains that the structure of many multi-asset funds does not lend itself to adding true diversity when stacked alongside the rest of an institutional portfolio. “The majority of multi-asset funds are still driven by market returns,” she says. “You may think you’re buying diversity, but you’re just buying equity and credit beta.”

Providers need to build up expertise in alternative asset classes in order to produce a product that is a better option than passive funds, Nikulina adds.

Stamford Associates Founder and CIO Nathan Gelber is even more scathing about those groups attempting to cover all the asset-class bases.

“Balanced funds have been around since I started in investments 40 years ago,” Gelber says. “They were thoroughly discredited in the 1980s, in the main because the asset allocation skill was not in evidence.” After several iterations of ‘balanced’ products—typically basic combinations of equities and bonds—and the intervention of actuaries, we get to the current model. “Now smart marketers have said they can provide investors with a free lunch,” Gelber adds, evidently not convinced.

“Whether it’s diversified growth funds, multi-asset strategies, whatever you call it, at the core is the assumption that the manager has the skill to make long-term asset allocation calls and select the appropriate asset classes by predicting inflection points and future returns,” the Stamford CIO continues. “You find providers insist on delivering everything under one roof. We are cynical about multi-asset strategies and the providers that propagate such comprehensive skill sets.”

Take heed, BlackRock, Russell, and the rest: The big institutions you may be eyeing are not going to be swayed by a well-marketed equities-and-bonds package.

Even a long and strong track record won’t save you. “In the last 15 to 20 years we have seen a bond market rally with no precedent,” says Gelber. Anyone could have made money from the carry trade in that period, he argues, buying low interest rates and selling higher rates. Soon, however, that will change.

“It is likely to become painful in the event interest rates rise and bond prices fall,” Gelber states. “There are many market participants who haven’t dealt with that environment yet.”

What about a more tactical, or short-term, role for third-party managers? For Publica’s Beiner, there exists the possibility of working with such managers on a tactical allocation basis. He returns to the earlier example of a 5% allocation to emerging market equity and 5% to emerging market debt.

“I could pick multi-asset managers, but give them a little bandwidth to move underweight or overweight one or the other asset class or risk factor,” Beiner suggests. Instead of a free rein, allowing “tactical asset allocation” within set boundaries is a little more palatable for the Swiss CIO. Within clear guidelines, if you want the same group to have that tactical freedom then that could make sense, he argues.

If managers are willing to be more flexible—and for the big mandates, they will be—asset owners can see multiple benefits.

An external multi-asset manager can also act as a “knowledge transfer,” says Beiner. Publica has a number of partnerships with third parties which share valuable information with its internal investment team and provide a healthy challenge to its ideas. While these third parties do not currently include a multi-asset manager, the CIO admits one could join under the right circumstances.

“They use certain information, or apply certain processes, that could be valuable to us,” Beiner says.

Other pensions have also sought to exploit managers for more than just bottom-line returns. Speaking to CIO last year, Stefan Ros, investment chief at Sweden’s banking industry pension SPK, explained that “if we have a large fund manager running a specific mandate, then we are also interested in other areas: other asset classes, capabilities, and services—for example, producing analysis or asset-liability matching.”

Coal Pension’s Dunatov echoes this sentiment, but emphasizes that a strong culture is important to ensure a relationship with an external provider can truly help the internal team, and not hinder it.

One of the leading lights in asset owner-manager partnerships is the Teacher Retirement System (TRS) of Texas. CIO Britt Harris has created a strong culture within his internal team—described by Harris as an “extreme” culture in a 2013 interview with CIO—and extended that to external asset managers.

The $125 billion US public pension allocated part of its portfolio to a public markets “strategic partnership network” in 2009, splitting the pot equally between JP Morgan, BlackRock, Morgan Stanley, and Neuberger Berman.

According to the fund’s website, the four groups are tasked with providing “insight and support” and “customized timely investment research and training” to TRS’ internal team. The groups should also use TRS’ investment network “to develop product and process expertise to help ensure that the investment management division is world class in every respect.”

Oh, and they each have $1 billion to invest. (Barclays earned a $500-million slice in 2011, but exited the programme in 2013.)

The managers run money across global equity, “stable value,” and “real return” tranches in accordance with TRS’ overarching risk allocation framework.

Under the leadership of Harris and David Veal, the former director of strategic partnerships and research, the pool has grown from $4 billion at its establishment in 2009 to $6.1 billion at the end of September 2015. Not a bad return—and proof that, with the right culture and cooperation between internal and external teams, some forms of multi-asset can work.

Steve Sexauer has been CIO at the San Diego County Employees Retirement Association (SDCERA) since May 2015, and finished transferring assets from previous outsourced-CIO Salient Partners in August. SDCERA’s board hired Sexauer after deciding it didn’t want a portfolio reliant on risk parity—leverage!—after all.

“There is clearly a role for multi-asset portfolios,” Sexauer declares, despite being responsible for mopping up an allegedly failed one. “You could give money to that portfolio manager, provided you have a benchmark by which they will be measured on a risk/return basis, and the fees are a win-win. In other words, if they add value, you pay them, and if they don’t, you don’t.”

For Sexauer, it is a simple case of following the rules of the mandate. Beat your benchmark without smashing through the risk budget, keep your fees low, and the job is yours.

“That’s a completely legitimate strategy,” the CIO says. “These are the rules of the road: there’s a benchmark and measurable risk guardrails, and over time after fees they beat a passive alternative in a measurable way. And if they can, they should be paid for doing it in a way that the portfolio benefits and they benefit. It’s not very complicated.”

But doesn’t this asset owner want to keep control?

“Did we give up something? Yes. We could have said that our staff sets the global asset allocation and picks which sectors to be in,” Sexauer explains. “But we’re saying, ‘No, we have 6% allocated to a global equity fund and we’re in an index fund with low fees.’ If you can improve on that then we’d be better off.”

The 21st century model of multi-asset is clearly changing. Off-the-shelf products won’t attract the attention of many large asset owners. But rather than shutting the door entirely, investors are becoming open to what a partnership can offer.

A word of advice to asset managers: Don’t think you’ll be left alone with that mandate. Seriously, those CIOs—they’re control freaks.