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Are multi-manager funds worthy of a spot in your portfolio?

Take the best stock ideas from a half dozen of the world's best money managers, put it into a single mutual fund, and presto - you've got the hottest concept today in the Canadian mutual fund industry. They're called multi-manager funds and were first launched in the late 1980s and early 1990s from companies like Fidelity and Global Strategy boasting of the benefits of style diversification. While the concept is very attractive, it has its limitations. This week, I'll explore the good, the bad, and the top picks among the new entrants.

The Appeal

The last two years has been the most glaring example of the fact that stock picking styles go in and out of favour. On a global basis, value has been in the doldrums for about three years while growth and momentum have taken over in a market infatuated with technology. Assembling four or five managers, each with a distinctive style that offset each other nicely should, as the theory goes, result in smoother returns. Portfolio research in recent years has made a strong case for something called "style neutrality". That means the portfolio isn't fully committed to any one style, but rather uses many to improve the risk/return tradeoff. That's what the new multi-manager funds are trying to exploit, but they're not for everybody.

Suitability

Since these funds are supposed to provide optimal global diversification, the funds are best suited for the simplest of portfolios. Let's face it, if you already hold fifteen or twenty mutual funds, adding a multi-manager fund is silly. Multi-manager funds should only be added if it's your only global stock fund, otherwise you won't benefit from holding such a fund. If you have a larger portfolio (more than $500k) or are in a high tax bracket, you should probably stay away from multi-manager funds since better and more efficient fund alternatives exist at that level.

A high marginal tax rate is another good reason not to hold a multi-manager fund. Portfolio managers that trade more heavily will add a healthy chunk to your tax bill each year if held outside of your RRSP, making buy-and-hold funds ideally suited for taxable accounts. Let's say the fund you're buying includes a global value buy-and-hold manager, in addition to a manager who picks stocks using an earnings momentum strategy. If you're in a higher tax bracket, you'll want the "global value buy-and-hold" manager outside of your RRSP while holding the heavier trading "momentum guy" inside of a tax deferred account since he will likely generate substantially more taxable income distributions. Such a simple, yet customized, solution just isn't possible with multi-manager funds because it's all prepackaged in fixed proportions. While the multi-manager structure is good, it has its limitations in that it can't accommodate customized solutions for certain investors. If you still think you're suited to hold a multi-manager fund, read on for my top picks in the category.

Top Picks

The following opinions on the multi-manager funds are in order of preference, with overall ratings in brackets (a rating of B or higher is a buy rating).

Universal Select Managers (A-)
This fund gets top marks in style diversification for including truly different styles from world class money managers Henderson International, Peter Cundill, and Mackenzie's in-house team. I love the inclusion of Peter Cundill, whose Value fund has always provided good diversification against most other stock funds and great downside protection. The inclusion of a dedicated US small cap component is also a positive and further enhances diversification and return potential.

CI Global Managers Sector (B)
This is one of the many share classes under CI's "tax-deferred umbrella" structure which allows investors to switch to other classes without immediate tax consequences. So this may be the top choice for tax-conscious investors. Dan Jaworsky (BPI Global Equity Value) and Bill Sterling (CI Global) tend to have much higher turnover rates than John Hock (CI Global Value) and Nandu Narayanan (CI Emerging Markets) so expect the turnover rate for this fund to bounce between 110% and 150% annually. (Turnover rate is usually expressed as a percentage and measures, on average, what proportion of the portfolio is traded annually.) The tax deferred structure isn't perfect but it (along with other tools) should insulate unitholders from much of the potential flow-through of annual income.

AGF Multi-Manager Class (B-)
Big tech stocks are scattered throughout this portfolio and have been a performance booster. Despite the differing approaches, growth and momentum picks appear to dominate right now, but that is shifting since none of the co-managers have a specific technology mandate. Jeff Busby is the only true value manager in this fund, with the others being more growth oriented. This fund is part of AGF's own "tax-deferred umbrella" structure.

Spectrum World Growth Managers (C+)
As the king of the "fund-of-funds" approach, Spectrum has taken a different path to the multi-manager concept. The World Growth Managers fund will buy units of existing Spectrum funds. If the bond funds were excluded from the $36 million Spectrum Global Growth Portfolio, that fund would be very similar to the new World Growth Managers fund. Yes, there are some differences but the concept is the same and the global equity managers are the same (Mercury Asset Management and MFS). A dilutive structure, relatively low style diversity, and high fees are three good reasons not to recommend this fund.

Fund Name Style
Diversity
Industry
Diversity
Expected
Turnover %*
MER**
Univ Select Mgrs A B 65% 2.49%
CI Global Mgrs Sec B A- 148% 2.50%
AGF Muli-Mgr Cl B B 106% 2.50%
Spec World Grth C B 59% 2.70%
*Turnover rate measures, on average, the proportion of the entire portfolio traded on an annual basis. Expected turnover figures for all funds are estimates only, and may differ from actual outcome.
**MER figures for all funds (except Universal Select Managers) are estimates based on maximum management fees and typical industry operating expenses. Actual figures can only be known after one full year of operation.


All of the multi-manager funds have a rather large emphasis on the US (45% - 50%). As a result, technology is also a prominent theme in each. So, if your portfolio already has adequate representation in these areas, you don't need more. Like any fund, these are subject to manager changes, which have already hurt two of the funds highlighted. If you use these types of funds at all, use them wisely to ensure that you're not doing more harm than good to your portfolio.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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