In Part One of our interview with advisor Gene Needles, he describes some of the benefits of using institutional money managers, or subadvisors, to manage client investments.
Kate Stalter: Today, our Daily Guru guest is Gene Needles. He’s president and CEO of American Beacon Advisors and president of American Beacon Funds.
Gene, I wanted to start today by asking you to describe your manager-of-managers approach that you use, and tell us how that’s different from a fund of funds.
Gene Needles: I think the way I’d like to describe that is juxtaposing not just to a fund of funds, but in addition to that, a portfolio of funds. Because there’s actually three ways you can assemble diverse disciplines within a single asset class or a single style box:
- One is you can assemble a portfolio of different funds or managers in that style box and/or asset class.
- The other way is you can go out, and there are many fund families that offer fund of funds in the same style box or asset class.
- Then finally, the way we prefer to do it is through a manager of managers.
There are, we believe, some inherent benefits to a manager-of-managers structure. For one thing, in a manager-of-managers structure, we get to design the overall portfolio, if you will. In other words, we set the portfolio parameters.
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When you’re out buying a portfolio of funds, or a fund of funds, those underlying funds are the ones that set the portfolio parameters. So we have more control from that standpoint in designing a product.
The second benefit you get from a manager-of-managers product is: You’re able to offset, within the portfolio, gains and losses. That’s not necessarily true in a portfolio of funds and in some cases, funds of funds as well.
What I mean by that is: As a mutual fund, you’re required to distribute more than 97% of income and realized capital gains in a given year, but you don’t distribute losses.
So you might have in a fund of funds or in a portfolio of funds, you might have one fund that has some gains and another fund that has some losses in the portfolio, which are unable to offset those for tax purposes. That has a tax drag over time to taxable investors.
There are a number of other benefits to this, but I think the big benefit in all three of these potential products is to the extent that you have somebody who is overseeing the manager selection—is someone who is actually going to, on a day-to-day basis, oversee whether these managers are in fact adhering to the discipline for which you hired them, and whether they are performing up to the standards that you would require in that particular portfolio.
What I think sets us apart in this respect is a couple of things. For the most part—and there are some exceptions—but for the most part in our manager-of-managers structure, where we’ve got more than one manager per fund, they’re required to meet with us on a quarterly basis. So we get to see them live on a quarterly basis.
I think the other thing that makes us a little bit different is we’re not just a top-down manager selector, we’re also a bottoms-up manager selector and overseer of these products.
What I mean by that is a couple things. One, we’re able to see the portfolios live each and every day, so we know what they’re buying or selling as that’s taking place. That’s not necessarily true on a fund of funds or a portfolio of funds.
The other thing is that when we meet with these managers on a quarterly basis, as I would expect these other products to as well, we see the individual holdings of the portfolio.
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But we go one step further than that. We do a proprietary analysis of these holdings in terms of what their growth and value characteristics are. We go over them one by one for holdings, and if there’s a value manager, for example, where as a holding it doesn’t seem to fit in the portfolio, we have a lengthy discussion on that.
I think over time, that really keeps these managers, these subadvisors if you will, on track in terms of what we’re trying to build for our portfolio managers.
In addition to that, it also, I think, keeps them on track in terms of style specificity. If you look at any of our portfolios, whether it’s a small-cap value, a large-cap value, they have uncanny style consistency, because of this bottoms-up, top-down approach to manager selection and ongoing due diligence.
Then, I think the final thing that is true for not just manager of managers, but I would say funds of funds or even a portfolio of funds: if you’ve done the due diligence right—if you selected the portfolios with some thought as to how these portfolio managers work with one another or how they correlate to one another—you end up with a much smoother ride than you do on a single-manager fund.
That’s not to say we don’t like single-manager funds; we do, we have some. But you buy those for a slightly different reason than you would a manager of managers.
What we’ve found, particularly in our portfolios, is we tend to avoid the lowest of the lows, because if you have four managers in a portfolio, what you’re going to have is invariably some are going to outperform, some are going to underperform, but you kind of keep a more steady return vis-à-vis the competition than you would in a single portfolio.
We have literature that discusses this. It shows how the individual portfolio subadvisors have performed.
As you would expect, some of them are in the very top for a couple years, and then those same ones might be in the very bottom for several years. And yet the fund itself generally tends to outperform its peers, kind of there in the top third, if you will, among the subadvisors in the fund. And they outperform the benchmark as well.
Last year, our Small-Cap Value Fund (AVFIX) won the Ten Year Lipper Award as the best performing small-cap value fund in the category. The prior year, the Large-Cap Value Fund (AAGPX) was the best performing large-cap value fund in that category.
I would suggest to you that it’s not because we spent a whole lot of time in the top quartile; that’s just not the nature of the products. That’s not even what we’re trying to do.
We’re trying to provide very consistent, above-average performance over time. If you are able to do that—and it’s easier said than done—but if you are able to do that, you can end up No. 1 in a category just by avoiding the very lows of that category and providing consistent returns over time.
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