Alternatives Equities Blog

The Wisdom of Crowds: How Multiple Managers May Outsmart the Market

14 March 2024
4 min read
Two floors of wall-to-wall books on shelves at the magestic Trinity Library.
Vikas Kapoor| Head—AB Hedge Fund Solutions
Tomas Kukla| Global Head of Public Alternatives Investor Relations

Pooling the expertise of many hedge fund managers may help investors to generate consistent absolute returns over a full cycle.

“Less is more,” or so it’s often said. And in certain areas—painting, interior design—it may be true. But when it comes to hedge funds, there’s more than one way to invest.

Investors, in our view, can boost excess return potential with both single-manager hedge funds and a multi-manager approach. For some—particularly large investors with the resources to perform proper due diligence—a single manager with deep expertise in a particular investment strategy or sector may offer an attractive way to generate strong risk-adjusted returns.    

But we think a multi-manager approach can provide investors, including smaller ones, with a better chance to generate consistent absolute returns over a market cycle than exposure to a single hedge fund or the equity market alone. What’s more, we think a multi-manager approach has the potential to do it with less volatility and more effective risk mitigation. 

Multi-manager hedge fund strategies allocate capital to many independent portfolio managers and trading teams. Some pool managers that focus on different strategies. With others, the strategy is constant, but each manager brings different areas of focus and expertise. In a long/short equity strategy, for example, one manager might focus on technology, another on financials, another on healthcare. 

More Diversified Returns

The goal: to diversify exposures and generate uncorrelated and attractive risk-adjusted returns in up and down markets alike—with less volatility than the broad equity market. We believe that strategies that can do this consistently may prove a valuable addition to a diversified portfolio, particularly if growth slows more than expected and volatility rises in 2024.

For now, major central banks appear on track to engineer a soft landing, and higher-for-longer interest rates suggest there will be ample opportunity to generate alpha. But tight monetary conditions may also mean that investors should prepare for the possibility of a more pronounced slowdown. Spreading the wealth among hedge fund managers has the potential to help investors do both, since each manager is free to tackle its area of expertise with its own unique approach.

Depth and Breadth

Hedge funds aim to generate absolute returns through manager skill rather than simply participating in markets. Strategies are often designed to have less market exposure, or beta, than a typical long-only equity strategy. 

Yet no manager can expect to persistently outperform the market all the time. That’s why security selection and diversification are so important. 

In our view, outsourcing that responsibility to many experts, each with skill and detailed knowledge in a particular sector, has the potential to generate alpha more consistently than relying on a single expert who does many things. 

One or Many? Comparing Hedge Fund Strategies
A chart showing that single managers offer a narrower focus while multi managers offer more diversification.


 

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.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams, and are subject to change over time.

About the Authors

Vikas Kapoor is Head of AB Hedge Fund Solutions. He joined the firm in 2016. Previously, Kapoor was co-CEO and part owner of Ramius Alternative Solutions, which was acquired by AB in 2016. Before Ramius, he was a managing director at Arden Asset Management, focusing on portfolio construction and risk management, and was a member of Arden’s Investment and Management Committee. Earlier in his career, Kapoor was managing director of Deutsche Bank’s Absolute Return Strategies Group, where he headed the Quantitative Analysis and Applications Group. Kapoor holds an MS in computational finance from Carnegie Mellon University, an MBA (Hons) in finance from Tulane University and a BTech in mechanical engineering from Regional Engineering College, Kurukshetra, India. Location: New York

Tomas Kukla is Director of Business Development and Investor Relations for AB Arya Partners, responsible for maintaining existing investor relationships and developing and implementing comprehensive internal and external marketing plans. He joined AB in 2015 as an alternative research analyst for the US Retail business, working with the Strategic Relationship and Alternative Business Development groups. Kukla started his career at Rogerscasey, where he spent 11 years, first as an analyst in the Consulting Group, then serving as associate director in the Hedge Fund Research Group before becoming director of Hedge Fund Research. He holds a BS in accounting and an MBA, both from the University of Bridgeport. Location: New York