The Great Resignation: Has it increased the risk that comes from portfolio manager exits?
Talent is quitting. And new talent is hard to hire. According to recent research from McKinsey, 41% of employees in white-collar industries are at least somewhat likely to leave their current job in the next three to six months. In addition, more than half of the employers surveyed are experiencing greater employee turnover than in recent years, with nearly two-thirds of them also expecting these trends to continue or escalate.
This presents challenges to asset management firms, as their lead portfolio managers, who are responsible for decision making on their strategies, may be among those choosing to retire or leave to a competitor. For asset managers relying on in-house talent, it may be a considerable task to replace star portfolio managers, putting assets under management and sometimes even strategy viability at risk should clients decide to take their money elsewhere while the dust settles on those succession plans. This creates risk for clients as well, as they would be losing the main decision maker who was managing their assets.
This is where a manager-of-managers approach can provide support and mitigate risks, especially if you’ve partnered with an OCIO (outsourced chief investment officer) provider with a robust manager research process to drive the decision of whether to stay with an existing strategy or to leave to a new money manager. Best-in-class managers-of-managers also take a total portfolio approach to find the right fit for the overall portfolio while continuing to manage assets during manager changes. Strong operational capabilities in onboarding and implementation can further mitigate the risks around changes to ensure a smooth and timely transition without foregoing critical market exposure or incurring undue costs.
Making a decision – importance of manager research
When a lead portfolio manager departs a firm, every client must decide whether to stay with the firm and the new decision maker(s) or to take their assets elsewhere. This is where a manager of managers, particularly one with a robust manager research platform, may have an advantage over asset managers relying on in-house talent.
An important aspect of a rigorous manager research process is evaluating investment strategies over time and keeping an eye on any potential style drift - where the portfolio composition and performance patterns move outside of expectations for the strategy. Team changes, more than anything else, increase uncertainty around strategy continuity (or consistency), leading to many research providers formally putting a strategy under review following portfolio manager departures.
For a client, it may be appropriate to stay with the current investment mandate, particularly if the asset manager had a team-based approach to investing, had a well-planned succession strategy and the departure was known in advance. But even in an event of a change that was well-telegraphed, there are several key considerations. While anyone can be replaced, it’s important to have confidence in the continuity of the process that led to prior success. Does the successor to the exited portfolio manager have experience making investment decisions? Is she aligned with the existing process? Has she been part of the team for a considerable time? Deep knowledge of the existing strategy and all team members as well as their contributions to the strategy are essential in evaluating the risk of the new decision maker.
Most of the time, a portfolio manager’s departure will lead to changes. This can be particularly impactful in cases of a small team, or when there’s a big gap between the experience level and tenure of the lead portfolio manager and the more-junior analysts. In these cases, risks may be higher that the strategy will change dramatically or even that it may be discontinued. Any change raises uncertainty about the continuity of expected performance, and it may be safer to terminate the manager and assess from the sidelines.
We have intimate knowledge of this process and its impact. Over the last several years, Russell Investments evaluated a number of leadership changes among the over 14,000 strategies covered by our manager research team. Several years ago, the portfolio manager of a highly ranked and funded strategy announced his upcoming retirement, and the research team spent considerable time evaluating the succession candidate to ensure that he was a credible portfolio manager who would maintain the stability of the process and expectations of the strategy. Ultimately, Russell Investments made no change in the rank, and the strategy remained in the portfolios, with clients benefiting from continued strong performance. Around the same time, a different funded investment manager was acquired by a larger firm, and the team instability warranted a downgrade in the rank, leading to an exit from the strategy.
Finding a new manager – OCIO and total portfolio approach
With the ongoing great resignation increasing the risk of departures of lead decision makers, it’s now more important than ever to have a back-up roster of qualified strategies that contribute to total portfolio objectives. We believe an OCIO approach that considers the total portfolio offers a superior approach relative to traditional fund of funds.
The foundation of making an informed decision about a replacement manager strategy is having access to information, including both breadth and depth of research. An open architecture approach and access to managers around the world provides the deepest pool of talent, and having detailed data makes it possible to analyze this opportunity set for the best portfolio fit.
An effective manager of managers will have a list of back-up candidates for the currently funded strategies and a strong roster to step in if a change needs to be made due to a portfolio manager’s departure. But it’s not simply about having a highly regarded manager in the same style as the incumbent. A key consideration when adding an investment strategy to a multi-manager portfolio is what role it’s expected to play and how it interacts with the other strategies in the portfolio. Evaluations of style, correlation with other managers, diversity of process drivers and other attributes are integral to ensure that the overall risk and return characteristics don’t deteriorate but instead improve with the new addition. Rather than viewing managers as stand-alone parts of the funds-of-funds structure, a manager of managers considers the portfolio as a whole, with contributions and interactions of the individual managers for the benefit of the total portfolio.
Additionally, some changes may present a favourable opportunity - a star portfolio manager may leave an established firm to start their own shop. And being an early investor in their strategy can reap considerable benefits to clients, like the greater flexibility and motivation that may come with low assets under management. An effective manager of managers may keep an eye on the industry resignations and new firm or strategy creations to take advantage of these opportunities.
We saw this in 2016, when a long-tenured star portfolio manager left his well-established firm to start his own company. This event provided an opportunity to be one of the early OCIO providers to add his strategy to our client solutions. Our clients benefited from improved access to the manager, from flexibility - given initially low assets under management - and from reaping strong returns. Some traditional funds of funds had a challenging time doing the same, as they tend to require several years of performance track record of the firm, but we were able to leverage existing research on the manager and the knowledge of his process in order to get clients invested early.
More recently, we had the need to replace a defensive value manager strategy. In one mandate, the defensive value manager was replaced by a market-oriented global investment strategy from a newly started firm. In another, they were replaced by a combination of a quantitative global defensive income strategy and an active international contrarian value manager. In both instances, customised positioning strategies directly managed by Russell Investments ensured that the portfolios maintained their preferred positioning and risk exposures.
Interim management within the total portfolio
While having a plan in place is essential, it’s critical to manage the assets before a new manager takes over. A manager of managers should have an effective process for managing the assets before the transition to a new manager is complete.
Once the decision is made to proceed with a manager change, an OCIO provider needs to take care of the client’s assets from the time the previous manager is no longer responsible for them until a new manager is in place.
A rebalancing across other managers in a multi-manager product may not be appropriate, especially in asset classes with high transaction costs or where existing managers have capacity restrictions. Depending on the role the previous manager was playing in the overall portfolio, it may be more suitable to replace their allocation with an internal strategy or broad market exposure. What’s key is an awareness of what total portfolio market exposures and risk profile are like and what a deviation may mean relative to the client’s return, risk, liquidity or spending objectives. The manager of managers capabilities in internal strategies and overlays will also determine how effective they can be in safeguarding the client’s assets.
Effective transition – operational strategic partner
Finally, a manager transition is a complex process, and having a strong operational strategic partner with appropriate governance, operational and trading capabilities can dramatically improve the client experience.
In addition to considering the investment rationale for a new strategy, robust due diligence process on the firm is key to ensuring that regulatory and compliance requirements are met. Particularly if evaluating a new firm or one operating in a different region, it’s important to evaluate the operations and risk controls.
As most clients and funds of funds tend to have long-term relationships, they don’t go through transitions often, which can make the process lengthy, costly and complex when they need to do it. Operationally, transitions can be multifaceted, including legal contracts, strategy guidelines, considerations of different regions and custody accounts being opened. A dedicated team with expertise in onboarding will provide timing and cost advantages.
One last thing: Trading capabilities are important to consider in an operational strategic partner, such as an OCIO provider, particularly when large sums of capital need to be traded from the incumbent allocation to a new manager. Ensuring that costs are kept under control, that the trading produces no undue impact on market and that the portfolio is not left out of market in cash are all factors to consider when choosing a transition partner.