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The multi-manager sector has become highly newsworthy over the past few months. There have been numerous high profile multi-manager moves as fund management companies look to promote their own competing products or the managers themselves decide to go it alone.

Why all the sudden excitement? Multi-manager funds are becoming a key part of many advisers’ businesses. According to the IMA, over three years to the end of December 2007, assets under management at around £34bn are up 128 per cent compared to total funds which are up by around 70 per cent. Multi-manager funds have become an outsource option for well in excess of 50 per cent of the intermediary market, who are looking for solutions to tailor to their clients’ financial plans. The changing regulatory landscape supports this approach (consider the requirements of the RDR, TCF and Mifid). The multi-manager industry certainly appears to be coming of age and multi-managers are in demand.

Deciding that a multi-manager approach might be the right solution for your clients and your business is only the first step in the decision-making process as the diversity of funds and propositions has increased markedly. This is clearly a positive development for investment fund buyers as they now have greater choice and are better equipped to satisfy their clients’ needs but it also introduces greater complexity and increases due diligence requirements.

It is therefore more important than ever to understand what a multi-manager is seeking to achieve, rather than simply judging the success of a fund compared to a sector average.

For a majority of multi-manager funds, the key differentiators are:

•The approach to asset allocation - fixed or active: are the managers seeking excess performance from asset allocation decisions compared to the benchmark and to what extent?

• The return bias – absolute or relative: are the managers highly ‘benchmark aware’ or are they less constrained, positioning the funds with a view to generating attractive returns over a particular timeframe? More than that, do they have a specific target return in mind?

We have segregated multi-manager funds into five categories which we believe provide a good starting point from which further research can be conducted. They are based around these two main differentiations and include fixed asset allocation on a relative return bias; fixed asset allocation on an absolute return bias; active asset allocation on a relative return bias; active asset allocation on an absolute return bias; and target return objective.

These categories have been kept deliberately broad in order to provide a useful starting point without being overly prescriptive. Historically, the fourth category has been the most highly populated sector but this is changing gradually as the industry develops and other approaches are adopted. The last category has been more recently added and this includes funds that have a specific absolute return target (for example, Libor plus 4 per cent or CPI plus 4 per cent), usually to be achieved over a market cycle through a multi-asset portfolio. This approach has become a more viable option for multi-manager funds thanks to the greater flexibility afforded by Ucits III and Nurs rules.

While plain vanilla multi-manager funds still exist, we are seeing more and more managers using different vehicles to express views, increase diversification, enhance yield or take advantage of pricing anomalies. Examples of vehicles that we now commonly see in portfolios are: investment trusts, futures, ETFs (including commodity ETFs), structured products (with various characteristics – capital protection, accelerated returns, bear notes, high yields) and absolute return type vehicles (for example BlackRock UK Absolute Alpha or funds of hedge funds).

In many cases, these vehicles are being used in reasonably small proportions in order to retain the spirit of the fund’s mandate but it is a trend that is worth monitoring. In the case of Insight Investment, it has moved the fund of funds proposition (with shareholder approval) almost entirely towards a multi-asset proposition in its Diversified range.

Multi-asset investing is certainly coming back into vogue as the markets become more turbulent and those who have the experience and resources to run such mandates should be well placed to do so within a multi-manager structure.

The multi-manager market is becoming more sophisticated and providing some excellent solutions for advisers and their clients. Knowing what you are buying and what to expect of a product remains a priority; following the development of that product and its continued suitability for investors is a necessity. Personnel changes are clearly not making this job any easier. Nevertheless, 31 flavours are certainly better than just plain old vanilla.

Gillian Hutchison is investment research director at OBSR