The Debate in a Nutshell

Despite their differences, protagonists on both sides of this debate typically have in common the view that split funding - the appointment of more than one investment manager - is a valid concept, with the simple aim of diversifying "manager risk". Since both the ownership and management of a fund management company can change, they agree, it is prudent to ensure that not all eggs are in one management basket.

In essence, both sides are also aiming to answer the same fundamental question: Where are the skills which add value?

The differences between the two groups emerge in their approach to analyzing and comparing the skills of a fund management group. These skills can be broken into two essential categories: asset allocation (the apportionment of a portfolio among the various asset classes); and stock selection (the identification of which securities to invest in within each asset class).

The Specialist Case - Pros and Cons

Some of the main arguments advanced by advocates of specialist fund management are:

• Asset allocation is too important to delegate to external managers, who may be more concerned about their position on industry league tables than the client's individual risk profile.

• On an industry-wide level, balanced managers may be moving funds in opposite directions at the same time, thereby wasting transaction costs by effectively trading between themselves.

To these objections, proponents of balanced fund management respond, in turn:

A well-run balanced manager should not have any serious weaknesses which are not already in the

• The manager's accountability for meeting its client's individual objectives is ensured by the proper use of benchmarks and sector ranges, which control the risk level and prescribe the limits of the manager's discretion.

• The question of wasted transaction costs is rarely an issue in practice. Asset allocation is often adjusted through derivative instruments, which incur very low transaction costs. In any event, managers are often moving in the same direction, responding to the same changes in the economic environment.

Apart from defending themselves against specific objections raised by specialist management advocates, the proponents of balanced fund management also argue:

• Strategic asset allocation (ie. the long-term asset mix adopted by an investor) itself needs to be reviewed and updated in response to changing economic or regulatory conditions. A system which relies on specialist managers is cumbersome and slow to react to this need.

Cost Considerations

In weighing up the relative merits of each side of this debate, one final factor to take into account is that of cost.

Use of specialist managers can involve significant costs at the asset consultant or financial adviser level, together with the possible cost (for large funds) of an "overlay" manager. These costs may to some extent be offset by the fact that specialist management in the fixed interest and cash areas is usually cheaper than balanced or equity management.

Cost considerations usually point to advisory costs being more easily absorbed by larger funds. Thus, a billion dollar superannuation fund will almost invariably employ specialist managers, while a personal investor may be more likely to rely on pooled balanced funds. In between these two extremes there is a multitude of different arrangements which different investors can and do adopt.

Conclusion

As can be seen, most of the debate over balanced versus specialist fund management is by no means black and white.

We believe it would be unwise to dogmatically adhere to either side of the debate, and that there is clearly a place for both styles of management in Australia's growing managed funds industry.