The more the merrier, or the more the more expensive? Multi-managers have grown significantly in the past few years, but what is driving the growth - and, more importantly, are they worth it? Shayla Walmsley reports

Depending who you ask, the primary investors in multi-manager vehicles can be either very large pension funds or very small ones. Ed Casal, CIO of the global real estate multi-manager group at Aviva, claims large investors find it easier to put money to work by commissioning one multi-manager than having to do due diligence on several managers.

He points out that the evolution of the multi-manager market in the UK has been speedier than in the US. In the US, large institutions believed they could do it themselves by investing in the underlying real estate. Often, he says, major US pension funds will invest directly in their local market but subcontract to multi-managers to invest, for example, in continental Europe. "They recognise what they don't know," he says. "There is a trend towards risk aversion."

In Europe it is different. "Big pension funds either do it direct or also do it direct," says Rob Bingen, head of European multi-manager at Schroders. Bingen identifies a typical multi-manager investor as a well-funded institution with an underweight allocation to real estate looking to increase its exposure gradually. "The smaller you are, the more likely you are to diversify via a multi-manager," he says.

As he points out, that makes for a pretty big market. Pension schemes in France and Germany tend to have a low weighting to real estate; in the Netherlands and the Nordics, the weighting has been historically higher but over the past year investors have "taken a bit of a pause" and the balance between equities, fixed income and property has shifted.

Pension funds with more than €3bn in assets under management tend to do their investments themselves, says Harry Humble, investment director at Hunter Property Fund Management. "But UK local authority pension schemes are big believers in multi-managers. Pull together 10 of them and you have €50m to invest."

For small pension schemes, there is an obvious reason to invest via a multi-manager. It offers a small, risk-averse UK local authority pension scheme with little or no existing allocation to real estate a nifty way to diversify. If one acquisition costs €100m, for example, a multi-manager can invest in five or six funds, each with 40-50 assets, and with a significant reduction in asset-specific risk.

Larger pension funds can afford to manage their assets in-house and their people are sophisticated enough to decide on real estate investments, to monitor those investments, and to develop exit strategies to get out of those investments, says Deborah Lloyd, corporate real estate partner at law firm Nabarro.

In Europe, smaller investors are becoming more risk averse and they want those decisions made for them, Lloyd says. Part of it has to do with regulations concerning trustees, which makes it their duty to get expert advice to avoid being accused of not having the skill and the knowledge to make investment decisions without consultation. Small pension fund managers with little knowledge about real estate could equally be considered negligent if they make investment decisions on behalf of the fund.

Nor will the pressure on pension trustees - one of the prime drivers of the market - abate. "The global financial crisis accelerated the trend towards multi-managers," says Casal. "Trustees faced with declining values had to re-examine whether, with one or two people, their resources were sufficient to do it themselves."

Multi-managers come at a price - and it is a price investors are often reluctant to pay. For investors increasingly concerned with fee structures and alignment, the fee-on-fees structure appears somewhat harsh.

That is not how multi-managers see it, of course. Fees have been pushed down, says Wendy Arntsen, head of multi-manager at DTZ. "Fees on fees are not intrinsically popular, though of course I would argue that it's worth it," she says. "The top-layer fee has been pushed down significantly. It isn't profitable to manage single accounts. The fees are too low to make it profitable to the business."

Fees are a significant issue not only because they will effectively draw the contours of the industry in future - either you have a scale business or you won't have a business - but because it could lead to multi-managers acting other than in the best interests of their clients.

"It's a competitive market, with low fee margins, handling large numbers of clients," says Arntsen. "That creates a machine. To meet the low-fee requirements, managers need to operate efficiently. So they use a house portfolio approach; they do due diligence on the funds; they design strategies; then they try to put each investor into a mirror portfolio."
The result is that multi-managers could have a number of investors in the same funds, giving them a powerbase in each fund.

"But clients want different things. They may want to increase or decrease their allocation - they may feel they have too great an exposure to Europe, for example," she says. "We see individual clients with exposure elsewhere, for example in a balanced fund, who then want to invest in the portfolio of a specialist fund. They expect to be treated as a separate client [rather than as an extension of the fund manager]."

Arntsen cites a portfolio that was invested in 20 different funds, even though the client had existing investments in balanced funds. "Twenty different holdings is just too large a portfolio," she says. "It isn't the shape of portfolio that would have been best for the client."

Conversely, there is a good chance that managers will be reluctant to admit a multi-manager into a fund simply because it carries an aggregate risk: in the downturn, when funds had to be recapitalised, multi-managers had to report to 30 different clients. That could make it more difficult for multi-managers to get access to the best managers.

You can check out but you can't leave
More broadly, given the size of the operations and the size of stakes in the funds, not every client will be able to get out easily.

If you have a large pension scheme with a segregated account with a multi-manager, chances are that pension scheme will have written the rules of disengagement so precisely it knows when it can pull out and what it will get when it does. Not so smaller pension schemes - at least not according to Lloyd. Investors wanting to move from one multi-manager to another could well find it a tricky business when that investor has invested a relatively small amount.

Lack of visibility is a problem. If a multi-manager pools capital from 10 pension schemes in a fund, what happens when that pension scheme decides it wants to change multi-managers? "The new multi-manager has to take over 30 little bits of investment," says Lloyd - and that's best case. Worst-case, the capital committed will be subject to the decisions of all the other investors.

Does it concern pension schemes? "They don't think about it," says Lloyd. It comes down to pricing. If you've got lots of little interests, you have to sell them on the secondary market, which isn't necessarily easy. The investor might not get a price they want, so they might have to accept that there will be additional costs.

"There is no way around it. There is no easy solution because the multi-manager is trying to avoid overexposure to one investor."

"The consequence is that once an investor has appointed a multi-manager, they won't change without thinking very carefully about it," says Lloyd. "If they have to re-tender, they're likely to appoint the same manager unless it really is time for a change - say the multi-manager has been in place 10 years - or there are problems with the relationship. But you'd have to get to that point to make a change."

Often the holding will be registered in the name of a nominee. Arntsen tells of one case where the name of the former manager's nominee was still on the documents. To be able to vote, they had to change the nominee, but the underlying fund manager wouldn't accept the change. Other investors began to gang up on the client because they would have had to sell their stake in the fund as well. Arntsen suspects the manager was hoping to acquire his former client's stake at a secondary discount.

Anecdotally, consultants are starting to see the risks - but it has not had much impact when it comes to choosing managers. "It might take a while but it's importance will possibly come through consultants, when clients raise with consultants the fact that they aren't happy with their portfolio," says Arntsen.

Let it grow, let it grow
The multi-manager business will grow bigger, to be sure, but it will not always look as it does now. For one thing, it will be much more difficult to start from scratch, says Humble. The margins are slim but it takes scale to support the overheads. "The revenues are very small but the resources you need are very large," he says.

Bingen forecasts significant growth for the multi-manager industry as a whole. "Then a few managers will amalgamate their portfolios and want to be very large," he says. "But multi-managers needing to invest for all their clients might not find a fund able to absorb the demand."

Just as club deals and bespoke funds have gained traction among large property investors more generally, these same investors are demanding the same kind of clout to direct strategy in their multi-manager arrangements. But multi-managers will likely face more demands from increasingly savvy investors, too. From the capital-raising point of view, pension funds want to invest with pension funds or sovereign wealth funds, which in turn prefer to invest with large pension funds.

"The appetite for multi-manager will continue," says Lloyd. "The appetite for control is a luxury for big investors."

Humble predicts that smaller-scale managers will find opportunities to exploit differences in style, taking high-return approaches and investing in opportunistic underlying funds. These niche players will be "less about size and more about return," he says.

As the industry itself changes, it is unlikely that multi-manager will continue to have the same appeal to small pension schemes it has now - not least because large, savvy pension schemes are in a much better position vis-à-vis multi-managers than their smaller counterparts.

In any case, if they don't like it, what are the alternatives? Casal reckons the UK has an active multi-manager business because, in contrast to the US, it doesn't have a strong REIT market. Before the financial crisis, in the US government budget pressures on state pension funds made it difficult to increase their size; there was more demand for investment under $1bn (€0.7bn). "Alone, we've reviewed 200-300 fund opportunities this year. Pension funds wouldn't have the resources to do the same. So they ask us to look through all the opportunities, including in niche areas such as assisted housing," he says.

But multi-manager, still not much more than a decade old, will mature and to some extent at least the market will out: those multi-managers not acting in the best interests of their clients will go by the way. Rigour has improved, says Casal. "The bar has been raised. It's the inevitable evolution of professionalism that goes on with any industry. If there is another prolonged period of stability, then the do-it-yourself motivation will come back but for multi-managers the mantra is: think rigorously, act prudently, and be a safe pair of hands."

In any case, adds Humble, investors do not have much choice. "If you're a small pension fund in the UK, what are your alternatives? A sleepy fund or a sophisticated, diversified multi-manager," he says.