The issues may be unchanged, but multi-managers are scrutinising the capabilities of their fund managers very closely, says Jenny Buck

Arguably what a multi-manager is looking for today is no different to what it was three years ago. A fund manager should be able to demonstrate that:

It has a good track record, which was derived from a clear investment process; It is aligned with investors; Its fees are fair and transparent; It has strong corporate governance and risk management, and exceptional, relevant reporting.

Given the experiences that we have all felt over the last few years, the bar that fund managers now need to jump over is, in my opinion, much higher. Below, I comment on the ways that our investment process has evolved at Schroders along with some observations on what we are seeing in the market place in general.

Underwriting evolution
Over the last three years, the issues that have generally taken up more time than in the previous three years have revolved around debt, treasury management, valuations and corporate governance.

On the debt side, we focus much more on a fund manager's debt management credentials, debt philosophy, proposed strategy and, increasingly, the relationships fund managers have with banks. Will they be able to obtain the debt that they are proposing?
The Landesbanki crisis particularly focused our minds on cash management and counter-party risk. It is surprising how few managers really think about this, even now. Many argue that they do not hold material sums and so it is not relevant to them.

Valuations across the world have been under scrutiny in some form or another over the last two years and have arguably caused the industry a lot of trouble with respect to banking covenant breaches and redemptions on open-ended funds. This is not the place to discuss valuations. But stating the obvious, it is critical to ensure that you fully understand the valuation that the fund manager is producing, what accounting methodology is being adopted, who is doing the valuation and how it takes into account or not taxation issues, as well as how performance fees are being accrued. For us, this is especially important when we are buying or selling funds on the secondary market.

Corporate governance is another wide-ranging concept, the quality of which is variable. However good a manager thinks they are, they can always do better, and should engage with their investors as much as possible. Investors can see the issues as they arise and usually anticipate problems before being told. Investors, however, do not like surprises and also do not like procrastination. Investors also do not like having to make decisions quickly - they have clients or others to manage and get consent from.

I have also been disappointed with the way that independent advisers have kept their heads below the parapet. We now look to meet with these individuals before investing in order to get a sense of how proactive they are, or intend to be.

Marketplace developments
Some of the main changes in the market place over the last 12 months have been around fees, leverage, performance, alignment and due diligence.

Clean, transparent fees are now the order of the day. The ability for managers to charge for things like debt arrangement, lettings and sales has drastically diminished. Investors want a single, clean fee. There also appears to be a move away from catch-up provisions. Carry provisions appear to be moving to an 80:20 split over a given hurdle. Hurdle rates have moved in some markets, but not as much as expected when you take into account the fact that markets have fallen anywhere between 20% and 50%. In the past, it was quite common to see a higher carry over a certain hurdle rate.

Not surprisingly, there is now more focus on leverage and the amount that investors are comfortable with - this is right and proper. However, I suspect that the focus on debt investment process and debt professionals within a manager's team is not as great as it might be. How often do investors ask for the track record of a fund manager's debt strategy, and how it has added value?

Today, managers are being carefully scrutinised on their performance track record. No longer is the IRR from your previous funds sufficient. Investors want to see equity multiples, returns pre- and post-gearing, and at an asset level. They also want to understand where the returns are expected to come from in the proposed fund.
Alignment has always been a topic of heated debate, and remains such. Generally, investors believe that a manager should have money in a fund to ensure that they remain committed and focused. This is rational. But, it is worth considering what investors want from this alignment: maximisation of returns or risk mitigation? Why is there a greater focus on alignment on the higher-octane funds? Did alignment do its job over the last three years? Whose money is in fact at risk? What is the appropriate level of alignment?

With US President Barack Obama's recent proposals that banks should be prohibited from investing in private equity funds, and signs that groups may be disaggregating their banking/savings businesses from their asset management businesses, the ability of fund managers to put significant amounts of money into deals will diminish. The industry should be increasingly focused on structuring alignment to protect the downside and to ensure that ‘real' money is at stake, and it is meaningful in the context of the individuals concerned. This, however, poses a number of challenges for employers: can you insist your staff put their own money up and can you ask them to show their net worth to clients?

Investors are now spending more time on due diligence. They want to look under every stone, and in many cases they are being given the time as it is still tough to raise money and close funds. Closings are also being affected by capacity - investors probably have smaller teams than they did two years ago.

In conclusion, I do not think multi-managers are looking for anything fundamentally different, but the emphasis is changing and I think there are some further developments to come.

Jenny Buck is head of Schroders' global indirect property multi-manager business.