To put it another way: single managers, many of whom tend to focus on a single sector, offer depth.
But because they lack the breadth of alpha ideas that a collection of many different managers can offer, they tend to take more beta—or broad market—exposure—to manage risk, which may limit return potential.
A strategy that allocates to multiple different managers, on the other hand, offers depth and breadth. Each manager’s expertise in its given area of focus offers the depth. But by focusing on different industries, using various investment techniques and holding hundreds, if not thousands, of securities, the various investment approaches are less likely to behave in the same way in a given market environment, creating collective breadth. These strategies also typically come with higher Sharpe ratios, which measure return per unit of risk.
The result: greater diversification and more potential to generate persistent alpha-driven returns over time.
Hiring and Firing
A multi-manager approach is unique in other ways, too—particularly when it comes to managing risk. After all, investment performance across strategies varies. In any type of market conditions, some managers will do well and others may struggle. That’s why diversifying across multiple managers may generate better risk-adjusted returns over time.
Multi-manager structures provide central monitoring of the risks taken by each constituent manager, providing a level of independent oversight that’s typically absent in single-manager strategies.
This can make it easier to identify and temper downside risk. This might be done by creating pre-determined loss limits for individual managers. These are typically designed to stem losses when markets go against them.
For example, a manager who suffers a 5% loss over a certain time period might see its capital allocation cut in half. If losses continue, the manager can be fired—and replaced by a new one. While this level of risk management can constrain returns slightly in up markets, it can also provide more clearly defined downside risk than investors can expect from other investment approaches and may help to deliver more consistent returns over time.
Sizing Up the Opportunity
Hedge funds come in all shapes and sizes. Multi-manager strategies are no exception. Some parcel out capital to less than 30 managers, others to more than 300.
Strategic focus can vary, too. Some focus on “stock-picking strategies” rooted in the deep fundamental research of a limited number of securities, while others employ a systematic—or quantitative—approach to identify opportunities across a much larger set of stocks.
Both have their advantages. But bigger isn’t always better. Adding a new manager to a group of 30, for example, is more likely to boost risk efficiency, diversification and return potential than increasing a strategy of 300 managers to 301. The larger the collection of managers, the harder it can become to deploy the next dollar effectively.
Generating consistent returns has been a challenge across asset classes in recent years. It’s too early to say whether 2024 will be different. Uncertainty about the path of interest rates and growth may keep markets volatile and create new opportunities to generate alpha. We think hedge fund strategies will have a key role to play. But when it comes to a multi-manager approach, we see strength in numbers.
