By Richard Cole

21st March 2023

Multi-Manager Investing – Why Diversification Matters

Article written by Richard Cole, Fund Manager from Future Money LTD.

Multi-Manager

A multi-manager portfolio invests in a range of underlying funds which are each run by different fund managers. This provides exposure to multiple asset classes and investment styles, with the aim of building an efficient portfolio using specialist managers at each stage of portfolio construction.

Multi-Asset

In contrast to multi-manager portfolios, multi-asset funds consist of a single fund management team which buys securities directly from across global markets. This approach can help to reduce costs as sector specialist fund managers are not used but may lead to lower levels of diversification than present in multi-manager portfolios.  Multi-asset funds are often seen with higher levels of both stock specific and style specific concentration.

House View vs Range of Views

While broad diversification is possible in multi-asset portfolios, with just one fund management team in charge, there can often be a strong ‘house-view’ present with a dominant investment style. In multi-manager portfolios, a range of investment styles can be accessed by selecting specialist managers with differing processes. 

Style Bias

Some of the most popular funds of recent years have been multi-asset funds with strong biases towards a style of investing known as ‘growth’. This is where companies with high growth in revenue are favoured, regardless of current valuation levels. 

Growth Well Justified

With a concentrated portfolio it is possible to generate large returns when market conditions are favourable. This situation occurred for many growth type investments in the years surrounding the pandemic, where low interest rates helped justify inflated valuations for those exciting companies which look set to change the world. 

Turbo-Charged

Growth investing was already in vogue in the late 2010s as interest rates were already at low levels. Yet, with the onset of the pandemic, this trend was turbo-charged as central banks moved aggressively to further cut rates and to expand Quantitative Easing, making borrowing even cheaper and high valuations easier to justify for fast growing companies. With such a surge in performance, many of the multi-asset funds focused on growth investments performed extremely well, while many more diversified multi-manager funds delivered relatively modest gains in comparison.

Risk Emerges

This shows that multi-asset funds may be expected to outperform multi-manager funds if their style aligns with current trends.  Yet, this outperformance is only likely to persist as long as a turning point is not reached in the mentality of markets. It is here where the risk in a concentrated approach emerges. 

Growth Style Reached a Peak

Such a turning point was reached in late 2021 when central banks gave their first indications that interest rates would have to rise as inflation, which had been steadily growing through the year, was now on a path which needed intervention. This proved to be the peak for many portfolios wedded to the growth investment style. 

Value Style Flourishes

While 2020 and much of 2021 were very strong for some multi-asset funds, many of these highest fliers experienced similarly heavy losses through 2022.  During this period of increasing interest rates, growth investments floundered, while the contrasting style of ‘value’ fared much better.  Value focused investors aim to find assets trading on low valuations, and are less concerned with future growth rates.

Clear with Hindsight

When an investment fund is focused on just one strategy it is likely to experience periods of both particularity good and bad returns.  This can be profitable where an investor knows when to invest and when to withdraw, but it is often the case that turning points in markets are only clear with hindsight. 

Timing is Crucial

What’s more, with human nature and efficient investing not always in step, investors can find themselves drawn to an investment which has recently performed strongly.  Many of the multi-asset funds which performed so well during 2020 and 2021 drew in large numbers of clients over this period. This meant that many of those investors unfortunately entered after the large gains had been achieved and before the large losses occurred. A concentrated portfolio can be more sensitive to the timing of investment than a more diversified one. 

Softening the Ups and Downs

Multi-Manager portfolios have the ability to select investment funds with a range of investment styles, including both value and growth investments. This allows them to have lower levels of concentration and therefore the potential to experience less extreme ups and downs in their performance. 

Why Diversification Matters

While many diversified multi-manager portfolios, including those run by Future Money, did not experience gains to the same extent as some growth focused multi-asset portfolios through 2020 and 2021, when going through the negative markets of late 2021 and 2022, the losses were also much smaller. In Future Money’s opinion, this is why diversification matters.  A blend of styles within a portfolio may miss the highest of highs, but if it also misses the lowest of lows a more balanced, less turbulent performance profile can be achieved.

Important Information

Please note that the contents are based on the author’s opinion and are not intended as investment advice. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.