MassM

utual Funds | White Paper

A better fit for Retirement Investors

The Multi-Manager Approach —

Multi-manager funds have become increasingly popular among 401(k) and other retirement investors in recent years. This is not surprising since these vehicles can offer several attractive advantages over other investment alternatives particularly for investors focused on better retirement outcomes. However, maximizing these benefits depends on a well-thought out and disciplined process, highlighted by a rigorous approach to manager search and selection, pairing and ongoing monitoring.

In this paper, we discuss the key features of multi-manager funds, their benefits, and MML Investment Advisors, LLC’s (subsidiary of MassMutual®) unique approach to constructing them.

The Multi-Manager Approach — A Better Fit for Retirement Investors

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Multi-Manager Funds Overview Multi-manager funds offer the expertise of multiple investment managers or subadvisors in one fund. Fund sponsors assume the responsibility of selecting these managers, combining them into portfolios and monitoring ongoing performance. The managers operate independently within the fund handling assigned allocations as determined by the fund manager.

Multi-manager funds come in different forms. They may be multi-asset class funds which include managers that are asset class specialists. Open architecture target date funds are popular examples of this type of vehicle. Another variety is single asset funds, which typically pair managers that share the same asset class but differ by style or approach. Single asset funds are attractive for their style purity and are typically used as constituent elements of a more broadly allocated multi-fund investment strategy. Our focus here is primarily on the single asset fund.

Multi-Manager Fund Benefits Multi-manager funds are designed to deliver important benefits to both investors and advisors:

A Smoother Ride: Because they are diversified across managers with complementary styles, multi-manager funds offer greater potential for more consistent, risk sensitive, long-term performance. This is especially important for helping retirement investors minimize the behavioral biases that often lead to sub optimal investment decisions. Staying appropriately invested throughout market cycles enhances their ability to meet their retirement needs.

More Predictable Outcomes: The manager selection and ongoing monitoring processes in multi-manager funds are sophisticated and rigorous with significant emphasis on risk management. These critical processes help alleviate concerns about manager “blow-ups” while more adequately meeting the fiduciary responsibilities in product and manager selection of advisors, plan sponsors and consultants.

Better Portfolios: Single asset class multi-manager funds seek to ensure style pure products that are better suited to be constituents of broader diversified retirement portfolios. Employing multiple managers also makes possible the construction of portfolios with specific purposes, allowing for outcomes that are more closely aligned with investors’ needs.

A Simpler Solution: Multi-manager funds allow access to a greater range of managers without overwhelming plan participants with options. Data suggests that 401(k) plan participants are increasingly suffering from “choice overload” when faced with the broad selection of investment options in their plans. As a result, many plans are reducing the number of options, typically capping investment choices to fewer than 15 funds.

Multi-Manager Funds: Added Diversification for Better Risk ManagementSeveral studies have shown the diversification benefits afforded to investors from multi-manager funds. This diversification helps retirement investors, with a fixed investment time horizon and predetermined goals, meet their accumulation needs. Diversification doesn’t protect against loss in a declining market.

The expected portfolio value at the end of the investment horizon (terminal wealth) is paramount — not the ups and downs in portfolio returns over the investment period. The chart below exhibits the reduction in the standard deviation of terminal wealth in portfolios in specific asset classes when additional managers are added. The lower the standard deviation, the lower the risk associated with having an unexpected shortfall in terminal wealth heading into retirement.

For all equity asset classes measured, the standard deviation of terminal wealth fell significantly by adding managers to the portfolio. The most risk control from manager diversification is gained in portfolios with two to three managers. The incremental benefit of adding managers beyond this number decreases as the number of managers rises.

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Source: MassMutual. For illustrative purposes only.

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T E R M I N A L W E A LT H S TA N D A R D D E V I AT I O N F O R M U LT I - M A N A G E R P O R T F O L I O S

• Large blend• Small blend• Large growth

• Mid-cap value• Mid-cap blend• Small value

• Mid-cap growth• Large value• Small growth

Number of managers

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The chart shows the 52-week rolling returns of four large cap value oriented single manager mutual funds or ETFs and

the returns for a hypothetical fund (25% Blend) built from equal weighting of all four of these managers. The hypothetical fund serves as a proxy for

a multi-manager single asset fund. This shows the benefit of manager diversification as the volatility is substantially decreased.

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2014 2015 2016 2017 2018 2019

5 2 - W E E K R E L AT I V E R E T U R N T O R U S S E L L 1 0 0 0 VA L U E

• Value Manager A• Value Manager B• Value Manager C

• Value Manager D• Value Manager E

Source: Morningstar

By better managing portfolio risk through the use of multiple managers, investors can smooth their return streams in each asset class. In so doing, as the chart below suggests, investors will not suffer the extremes in returns that any single manager can experience in isolation.

Building a Better Multi-Manager ProcessWe believe active management by specialized investment managers supported by disciplined portfolio construction and ongoing monitoring can lead to consistent performance over the long term. To realize the full benefits of the multi-manager approach, however, a thoughtful, rigorous building process is required. In the following sections we discuss the key elements of our process, with a special focus on manager selection and pairing within single asset multi-manager portfolios. We also highlight the proven benefits of our approach for retirement plan investors and those who have a fiduciary responsibility to serve them. For over 160 years, MassMutual has been entrusted with protecting the financial futures of retirement savers. That north star is the guiding principle of MassMutual Funds as trusted stewards of our clients’ capital.

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Building Multi-Manager Funds — Manager SelectionWe believe in building multi-manager funds by hiring management teams that are “best in class” in their respective investment style. The goal is to find managers that can consistently deliver positive, long-term results while limiting volatility.

Screening manager universes through a variety of quantitative measures is the first step. These measures may include standard performance metrics such as rolling returns, manager batting averages and overall capture ratios. But a multi-dimensional view of performance evaluation extends beyond these to include measurement of management performance in various market environments versus expectations for their specific style. We evaluate the length and severity of drawdowns as well as the length and magnitude of outperformance. We seek to find the drivers of manager performance and uncover management’s ability to consistently deliver returns within expectations.

To those managers that pass our quantitative screens we apply a series of qualitative measures. These insights help us gain an intimate knowledge and understanding of the investment team and manager firm, and are critical in identifying the ability of a manager to help our clients reach their objectives. This review includes:

Information is gathered through an ongoing interview process between our Manager Research Team and our target firm’s management and professional staff. Once a manager is selected, an additional assessment is made of the firm’s compliance organization, policies and procedures, code of ethics and regulatory history. This may include an onsite due diligence visit to evaluate the sub-advisors risk management compliance and operations functions.

Evaluating the investment philosophy, process, and the commitment to style consistency. This dialogue is enhanced by our quantitative review to determine alignment and matching of stated objectives and expectations with outcomes.

Assessing how investment ideas are implemented and executed.

Reviewing the tenure and turnover of the portfolio management team to ensure stability and experience across market regimes for our investors.

Investigating ownership structure alongside the strengths and weaknesses of its organizational structure to not only ensure firm stability, but glean insight into the decision-making process to verify commitment to the prospective investment team and their resource needs.

Manager Pairing — Building the Portfolio Having access to what we believe are best-in-class managers is a key benefit of multi-manager funds. But the artful process of combining those managers in the overall portfolio of a multi-manager fund also contributes significant value beyond that available from typical single manager funds.

As the studies cited above show, this value comes in the form of risk control through diversification. Our approach is dedicated to the retirement industry, with a singular focus on how retirement participants construct portfolios. In building our single asset class multi-manager portfolios, managers are selected that invest within the same asset class but have unique and complementary styles. As a result of differentiating views on stock selection and portfolio construction, these managers will typically have minimal overlap in holdings and low correlation of excess returns.

Pairing managers in this way allows portfolios to benefit from enhanced diversification including:

In order to optimize returns and fully leverage the benefits of diversification, we employ a sophisticated portfolio construction process to build out our multi-manager funds. Allocation of capital across managers within the funds is strategic in nature and determined through a disciplined process that incorporates both quantitative and qualitative elements. This process examines historical returns both in a standalone capacity and alongside its complementary manager pairing. Backed by sound academic research, this review looks at various Modern Portfolio Theory statistics, both absolute benchmark relative and peer relative. This includes an examination of risk and return in various market regimes recognizing that a manager’s style varies in efficacy throughout market cycles and reacts differently to positive and negative market events. Qualitatively, we incorporate insights from our dedicated Manager Research Team who has deep insight into the manager’s strategy and style. Combining these two additive portfolio construction approaches has helped us achieve more durable and persistent returns on behalf of our clients.

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Style Diversification: Managers with different styles diversify the sources of returns. When one manager falls out of favor, the other manager(s) with low correlation may be in favor.

Portfolio Diversification: Fund holdings are likely to be diversified across a wider selection of securities with exposure to a broader range of holdings characteristics. This offers an opportunity for a larger investment opportunity set.

Business Risk Diversification: There are many factors that may influence the performance of a single manager including turnover, investment process drift, change in ownership structure, etc. Engaging multiple managers diversifies these risks.

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Ongoing Manager Monitoring In order for multi-manager portfolios to deliver on their potential over time, managers must continue to perform as expected. To ensure consistent adherence to their investment mandate and guidelines, the Manager Research Team monitors managers’ daily holdings and trading. Daily fund dashboards provide a number of portfolio metrics such as number of holdings, P/E, P/B, earnings growth rates and active share. Risk metrics are also applied including standard deviation, beta and tracking error all of which are measured against each manager’s investment objectives and investment style.

To compliment this daily review of fundamental characteristics and risk metrics, a robust quarterly investment review process serves as a key pillar in our oversight of the Fund complex. Our Manager Research Team rates their managers across people and process (qualitative), and performance (quantitative). Our review of performance takes a holistic view across rolling, trailing, and calendar year periods. A composite score is then generated that documents our conviction, highlights areas of concern, and informs our research agenda.

When managers veer from original mandates or are subject to shifts in quantitative or qualitative factors that compromise their ability to perform, the Manager Research Team is empowered to replace the manager or to shift their fund allocation.

This constant, layered monitoring helps to ensure that MassMutual’s multi-manager funds perform consistently and as expected given their asset class focus.

ConclusionMulti-manager funds are becoming an increasingly important option for retirement investors. They offer significant benefits including access to different manager styles within a single fund as well as consistent long-term performance. Multi-manager funds benefit investment advisors by easing the burden of manager search and selection, while allowing them to meet their fiduciary responsibilities to their investors.

However, not all multi-manager funds are created equal. Investors should look for funds backed by a rigorous process for independently identifying specialized managers in specific asset classes and have demonstrated capabilities for pairing and monitoring these managers to achieve the investor’s desired outcome.

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Citations

Is Multi-Manager Diversification Worth It?

https://blog.thinknewfound.com/2019/01/is-multi-manager-diversification-worth-it/

C O R E Y H O F F S T E I NJ A N U A R Y 7 , 2 0 1 9

Do You Need More than One Manager for a Given Equity Style?

https://jpm.iijournals.com/content/25/4/68

L . F R A N K L I N F A N T A N D E D WA R D S . O ’ N E A LS U M M E R 1 9 9 9

Hedge Fund Diversification: How Much is Enough?

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=322400

F R A N C O I S L H A B I TA N TA U G U S T 3 1 , 2 0 0 2

Notes:

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