This article explores a multi-manager implementation strategy, designed to leverage the strengths of skilled active managers while minimizing risks associated with their use.
Understanding Risk
Risk means different things to different investors—some prioritize volatility, others focus on drawdowns or the permanent loss of capital. Regardless of the definition, it’s crucial to manage these risks in alignment with specific investment objectives.
The Case for Multi-Manager Portfolios
While traditional asset allocation benefits from diversification across asset classes, multi-manager portfolios take this a step further. They blend various active managers to achieve complementary strategies, enhancing potential returns while mitigating risks. This approach allows advisors to harness the alpha potential of skilled managers without the volatility that often accompanies single-manager investments.
Overcoming Behavioral Biases
Behavioral finance plays a key role in investment decision-making. Cognitive biases like recency bias and loss aversion can lead investors to make poor choices, often abandoning strategies during downturns. A thoughtfully constructed multi-manager portfolio can provide a smoother return experience, helping investors stay the course and avoid emotional reactions that jeopardize long-term success.
Options Available to Investors:
- Avoiding Active Management: While this may sidestep timing issues, it also forgoes the potential benefits of skilled managers.
- Investing with Closet Index Managers: These managers may offer short-term comfort but typically yield subpar long-term results.
- Multi-Manager Approach: This strategy blends various active managers with low correlations of excess returns. It allows for the potential of enhanced returns while reducing volatility, thereby closing the behavior gap.
Balancing Risk
A key aspect of effective multi-manager portfolios is the allocation of risk rather than capital. Equal-weighting managers can lead to unanticipated volatility from a single manager. Instead, advisors should focus on balancing the risk contribution of each manager, which may require advanced risk modeling and quantitative analysis.
Conclusion
While managing risk in investing is challenging, adopting a multi-manager strategy can be a powerful tool for financial advisors. This approach allows clients to benefit from active management without succumbing to emotional pitfalls. By constructing a well-balanced multi-manager portfolio, advisors can help clients achieve their long-term financial objectives while promoting better investment behaviors.