Then went the devils out of the man, and entered into the swine: and the herd ran violently down a steep place into the lake, and were choked.  Luke 8:33

The City regulator is investigating funds worth more than £15bn that have holdings in Neil Woodford’s collapsed investment vehicle as it seeks to prevent the liquidity crisis surrounding the fallen stockpicker from spiralling.

The Financial Conduct Authority is closely monitoring multi-manager funds with holdings in Equity Income — Mr Woodford’s flagship vehicle that was suspended in June — over fears that investors in these products are vulnerable to contagion spreading from the failed fund. – FT 08/12/19

The question for me , is not what multi-managers have done with Woodford’s Equity Income Fund as what they are doing at all.

The idea of an investment fund is to pass direct control of an investment portfolio to an asset manager who can obtain economies of scale by managing your money in the same way as he/she does others.

At some point , a further level of intermediation was introduced because, it was felt, people needed to have a wider diversification of investments than could be achieved by one asset manager. Instead of appointing multiple asset managers to one fund, it was thought better to have multiple funds under a single umbrella, managed by a super-fund manager.

Multi-managers are not managing your money any more, they are simply managing the people managing your money and it is very likely that in this complex pyramid , there are more than just the two layers. I have heard of hierarchies of funds with eight layers and I have heard the multi-managers within that hierarchy boast of the complexity of what is on offer.

There are three immediate questions behind my big question (what do multi-managers do)

1. How are they managing the proliferation of costs from employing so many people?
2. How are they managing governance (voting rights for instance)?
3. Who is ultimately accountable for outcomes?

Cost proliferation

Over the weekend we learned that leading US universities endowments struggle to beat tracker funds.   It turns out that the decade of great returns enjoyed by equity funds have been enjoyed by Private Equity and public stocks alike. Ludovic Phalippou,. Professor of finance at Oxford university pithily explains why private equity – held by endowments – has underperformed.

“QE has also favoured private equity big time, but unlike Vanguard, they captured it all in fees,”

I do not get the maths, pay five people to do one person’s job and your outcomes are reduced.

Governance

The further you are from the voting rights, the harder it is to influence the the management of your assets. It’s common sense. If you have fully outsourced your voting rights through multi-management, you are relying on others to vote your shares and if those “others” aren’t exercising their rights, there is not much you can do about it.

The layering of fund management described above makes it harder to see what is going on at the coal-face. There is an issue of agency with all outsourcing of asset management , but that issue proliferates as layers of fund management proliferate.

Accountability

It is often said that the only free lunch available to investors is diversification. This phrase could be rephrased , the only free lunches are those enjoyed by asset managers within a multi-manager hierarchy.

A multi-manager hierarchy can quickly become a club. Clubs are great for members but they tend to be exclusive and some would say that multi-manager funds have the capacity to exclude the asset owners.

There is also a natural bias within clubs to protect those within the club and this is presumably why the FCA feel they need to get involved with multi-manager funds which have exposure to Woodford’s Equity Income Fund.

The idea that such funds may, as a result of write-downs in the value of their Woodford Holdings, fall off the perch of the league tables they sit in, is a marketing concern.

The idea that multi-manager funds might themselves become suffeciently illiquid to be gated poses an existential risk to such funds.

Multi-managers do nothing except diversify and the judgement call of any investor is whether the diversification of management justifies the costs of proliferation, the weakening of governance and the lack of accountability.

Since  multi-manager’s can only be judged on their  capacity to deliver out-performance, confidence among investors is especially important. The contagion that the FCA should be worried about is only too obvious.

Then went the devils out of the man, and entered into the swine: and the herd ran violently down a steep place into the lake, and were choked.  Luke 8:33