Chris Davies, head of EMEA Implementation Services at Russell Investments, explains the concept and its role in efficient portfolio construction, the challenges it presents for asset owners and how Russell Investments has successfully navigated these.
Few might think there’s a link between improving a sports team’s performance and outcomes in fund management, but the theory of marginal gains ties them together.
Popularised by Britain’s most successful cycling coach, Sir Dave Brailsford, the principle focuses on the notion that by making minor improvements in multiple individual areas of cycling, overall performance is amplified.
While cycling teams might be battling to get seconds off the clock, fund managers, including ourselves at Russell Investments, are constantly fighting to take basis points of cost out or improve the risk-return outcome while maintaining the rigour of our offerings.
This is becoming ever more urgent as fund managers face increased regulatory scrutiny and the related costs that come with meeting more robust rules, not to mention challenging financial markets and a business environment where margins are constantly under pressure.
While many fund managers might feel their cost audits are potent enough already, our Implementation Services team can help find areas where small savings or improvements can be achieved quickly and highlight changes to processes that could reduce the charges on a fund, improve the risk-return characteristics, but also increase the efficiency of managing the portfolio.
A potentially easy win for most fund managers can be found in foreign exchange (FX) trading.
Most portfolios require some element of FX trading to settle associated trades in underlying securities, but there is a huge disparity in execution costs, depending not only on who executes those FX trades but also on the execution process itself.
Broadly speaking, according to analysis prepared by FX Transparency (a specialist FX transaction costs analysis firm), the median cost of FX execution by custodians in their survey was 6.55 basis points, and those for the median asset manager who competitively tendered their FX trading was 2.59 basis points.
In the same period, the average cost of FX execution for our clients was only 0.43 basis points, providing a quick and easy saving.
Furthermore, when asset managers win mandates from other investment companies, maintaining discipline in relation to the transition costs can be difficult amid the excitement of the new assets.
We oversaw over £60 billion of transitions last year; as we look to minimise turnover by maximising the number of securities retained and thus not traded in the market and focus on those securities, or factors, with the highest marginal contribution to risk, this helps to both keep costs down and minimise risk.
Beyond paying less for specific services, many firms can also save even more money, and reduce the risk they are taking, by changing how they implement their investment mandates.
Multi-manager funds are a prime area where costs can be reduced, and with 50 years’ experience in this field, we’ve discovered more cost-efficient methods for such a strategy.
Whether an asset manager runs a fund-of-funds (FoF) structure or a manager-of-manager (MoM) proposition, changes to the architecture of a multi-manager product can quickly lead to compelling efficiencies and avoid duplicate charges.
By embracing Enhanced Portfolio Implementation, or EPI, firms can centrally implement their multi-manager model, improving operational efficiency, reducing the drag on investment returns, and reducing trading costs.
These benefits can be achieved to differing degrees depending on the level of change a firm wishes to make.
Moving from an FoF to an MoM can reduce costs because fees on segregated mandates tend to be lower than fund share classes.
Segregated mandates also provide more control for the investor, as their own desired parameters can be implemented – such as a style/Cap bias or implementing a bespoke ESG strategy – that can’t be imposed on a retail fund.
But asset managers can go even further by implementing a multi-manager approach that brings the functional processes of a fund in-house, leveraging only the intellectual property of the underlying managers.
For instance, if a multi-manager fund holds five underlying funds, then some charges are being paid multiple times.
These can be reduced on a segregated mandate basis, but they can be significantly decreased if the asset manager simply asks for model strategies from their underlying managers and then implement the trades once at the portfolio level.
By centralising trading, the turnover within a multi-manager portfolio drops substantially; we are often able to reduce turnover in such funds by nearly a third, which reduces tax and stamp duty bills, reduces the potential hit from trading spreads, and reduces commission payments.
Essentially, managing a portfolio that purely implements third-party fund managers’ best ideas rather than buying the funds of those managers has numerous benefits.
It means there is greater control and visibility over the product, all the way from trading and rebalancing through to manager selection and risk management.
This also extends to implementing an ESG overlay, which becomes easier and more coherent as it is being done by the firm that runs the multi-manager fund rather than in disparate ways by the underlying managers.
The asset management industry is often viewed as an adversarial arena where peers are competing for assets and trying to outperform each other, but our Implementation Services team puts rivalry aside.
Our team works with investment management firms to help them reduce the cost of their funds or find new ways of implementing their strategies – particularly multi-manager offerings – to help them deliver an even better value service for their clients.
Crucially, the service is not about outsourcing; we are not seeking to take on any part of a client’s business but rather act in a complementary fashion to support a firm’s beliefs, processes, strategies, and asset allocation.
Importantly, it is not a cookie-cutter approach, an attempt to fit a round business model into a square hole – we use our investment toolkit to address each firm’s needs in a way that acknowledges their differences.
And we are brand agnostic, meaning that those fund managers we assist can choose whether they wish to mention the use of our services to their clients or not.
The entire motivation is to help asset managers reduce costs by analysing every charge incurred, thus improving their risk/return profile and enhancing efficiency.
Cost is usually king in asset management, and every fund manager will face long-term and intermittent headwinds that dampen profits while costs remain fixed.
We believe we have unearthed some of the prime ways to shrink the charges fund managers pay just for doing business, and for those interested, we’re keen to share what we’ve found.
Chris Davies is head of EMEA Implementation Services at Russell Investments
For Professional Clients Only. Unless otherwise specified, Russell Investments is the source of all data. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate. Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice. Issued by Russell Investments Ireland Limited. Company No. 213659. Registered in Ireland with a registered office at 78 Sir John Rogerson’s Quay, Dublin 2, Ireland. Authorised and regulated by the Central Bank of Ireland. Russell Investments Limited. Company No. 02086230. Registered in England and Wales with a registered office at Rex House, 10 Regent Street, London SW1Y 4PE. Telephone +44 (0)20 7024 6000. Authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN. KvK number 67296386
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