By Richard Ennis and Neeraj Baxi
A "master manager" combines elements of an indexer, overlay manager, transition manager, master custodian and consultant to achieve the flexibility needed to seek alpha where one can find it, without being constrained by asset-class considerations..
Under such an approach, investors would continue to set their strategic asset allocation, such as 50% U.S. equity, 15% international equity and 35% fixed income. To add value, an investor would seek to hire managers with the highest prospective information ratios irrespective of the asset class. An investor could hire a manager in an asset class that is not included in the strategic asset allocation (e.g. high yield or emerging markets equity), or hire managers in international equity with an allocation greater than the strategic allocation (more than 15%), or hire long-short managers. But this would cause the actual allocation to be different from the strategic asset allocation. That's where the master manager comes in.
A master manager would perform the following functions:
• Implement the marketable securities component of the policy portfolio. This would be done using a combination of index funds, exchange-traded funds and derivatives as cheaply as possible.
• Make cash or securities available to fund the active managers. The master manager can use futures to gain exposure to certain market sectors. As futures require only a 5% to 10% margin, the remaining free cash can be used to fund a new manager. Or they may conduct a transition from a passive portfolio to an active portfolio.
• Monitor risk and compliance of the active portfolios.
• Neutralize any unintended factor exposures. If all the active managers are strictly market neutral, there will be nothing for the master manager to neutralize. For managers that bring factor exposures, such as stock market beta, a value bias, a high yield beta or unwanted leverage, the master manager would adapt its portfolio to neutralize the unwanted exposures.
• Rebalance the portfolio and balance the active risk budget.