Blending risk exposures in multi-management

‘The world of investing has changed,’ says Selwyn Pillay, CEO of Sanlam Investments Multi Manager. ‘But we’re ahead of the curve and our business has already adapted to these changes’.

Previously, we have talked about managing risk in passive portfolios (through smart beta or factor investing), we unpacked risk management in credit portfolios (through minimising concentration risk), and now we take this to the next level, and examine managing risk in a multi-management context.

Says Pillay, multi-management used to be all about asset allocation, building blocks and manager selection to construct funds that would achieve the client’s return objectives. ‘But the paradigm has changed. Now we select and blend risk exposures instead. It’s a subtle but important difference. We believe that you cannot manage returns, but risk is possible to manage – and through managing risk exposures we can achieve the client’s return objective,’ says Pillay.

Multi-management then and now

In the 1990s, post the years of prescribed assets, the multi-manager proposition revolved around finding the best managers in each asset class on behalf of clients. Those were the days before Google, and tracking down the smaller managers that were not part of big life insurers involved significantly more time and effort than today. The focus was on spreading the money across asset classes, markets and managers – and therefore diversifying risk in the investment portfolio.

In this phase of multi-management, a multi-manager was mainly focused on understanding the asset manager’s investment process and organisation to ascertain the likelihood of continued performance. Typical manager research would interrogate the manager’s organisation and their research capabilities. They investigated the skills and experience of the investment professionals managing the funds, checked that succession planning was in place and analysed if the investment process was robust and repeatable. Often the multi-manager’s fund would include the big brands with a strong performance track record with the advantages of lower fees than the available retail options.

“Multi-management 2.0”

The world has changed dramatically over the past two decades, says Pillay. Political and socio-economic turmoil, as well as the rise of technology, has made the investment world more complex – to the point of ‘noisy’. But on the positive side, we are starting to understand a lot of things better and can dissect managers’ DNA into finer detail than before. In addition, there are more strategies available, which is advantageous for the multi-manager. We are not confined to shares, or bonds that offer a margin of safety; we can choose from new capabilities as they emerge. These include hedge funds, smart beta, boutiques, Africa and other emerging markets, even private equity, says Pillay. The unique proposition of the multi-manager is the ability to have access to the next generation of investment capabilities.

‘However, even with all these new capabilities and strategies to choose from, we cut through the noise to remain focused on chasing the client’s fundamental need of capturing more of the upside with less of the downside. This is a lofty ideal and our best solution for this requirement is to create risk-opportunity asymmetry,’ Pillay points out.

What should a future-fit multi-manager look like?

In terms of creating risk-opportunity asymmetry, progressive multi-managers have evolved from the traditional approach of managing for returns; they now manage that which they can control – risk exposures in investment portfolios. And in doing so, the returns follow. Says Pillay, ‘instead of an asset allocation and manager allocation process, we follow a multi-strategy approach, combining strategies based on risks that will be rewarded.’

What makes Sanlam Investments Multi Manager different?

How does Sanlam Investments Multi Manager choose which managers to combine? ‘We research two components extensively: firstly, the manager’s style beta (or risk factor) and secondly, current market conditions (i.e. which risk factors will be rewarded or penalised), and our insights from these research processes inform how we construct solutions. Our manager allocation is therefore not static; we blend managers that will benefit from the risks that the markets are rewarding, aiming to capture more of the upside and less of the downside.’

Even though the focus has shifted towards risk management, multi-management 2.0 still involves blending managers to achieve the highest possible return for a universe given a level of risk. The combination of managers would, for example, look different when the market is not rewarding investors for taking risk than when the market is rewarding risk. The past two years is a good example of a period that risk was not rewarded, with equity markets being volatile but mainly trending sideways. Equities and listed property delivered only 2.3% and 3.2% p.a. respectively for the two years to 30 April 2017, but cash and bond investors (low risk takers) fared better at 7.1% and 6.1% p.a.

A richly diversified manager blend

Sanlam Investments Multi Manager’s funds are a combination of pure beta, style beta and alpha. ‘For style beta we choose the right managers that will give us some style beta, such as quality or momentum, and a bit of alpha,’ says Pillay. ‘For alpha we have an array of boutique and traditional long only managers to choose from, as well as hedge fund strategies. These managers all have different risk factors, which gives us varying options to construct funds.’

Sanlam Investments Multi Manager has transitioned towards a multi strategy approach, using multiple strategies and tapping into various risk factors to deliver on clients’ fundamental need to capture more of the upside with less of the downside.