Should We Diversify Managers?
Even inexperienced investors understand that diversification is important (eggs in baskets and all that). So does it make sense to spread your investments across different advisers and fund managers?
At first glance, this seems sensible. However, in most cases at least, diversifying across advisers and managers offers no real benefit.
What do we mean by diversification?
When we talk about diversification, we are referring to purchasing a range of investments to spread risk.
Let's say you were only investing in shares and your first purchase was Walmart. What are some of the things we know about Walmart which describe the associated risks?
Walmart is a chain of retail stores based in the USA. If we were to choose Amazon as our second purchase, we would be diversifying some risk; if Walmart does poorly, Amazon may be doing well.
But Amazon is also largely focused on retail in the USA. So we haven't really reduced our exposure to the risk of something happening in the retail market or something happening to the USA as a whole.
Any manager worth their salt will account for country risk and sector risk when choosing the shares in a portfolio.
Isn't using different managers diversifying?
It seems to follow that the same would apply to managers and advisers. Why put all your faith in one investment strategy or a single manager's products?
The issue is all the managers and advisers are choosing from the same pool of companies.
For example, think of ride-share apps like Uber and Ola, plus regular cab companies. Most of the drivers are on both services, even the cab drivers. So it doesn't matter which you choose, the same driver will show up regardless.
If the different managers are focused on the same market, you likely haven't added any diversification by using two. If one of the managers is Dimensional or an index fund, you almost certainly have not.
What happens if the manager fails?
Your funds should never be accessible by the manager's creditors. Investment products are set up as trusts, where investors buy a small part. The assets are held by an independent custodian (in Dimensional's case, this is Citibank) who receives and carries out the instructions of the manager.
If a manager went under, the client assets would still be held by the custodian. There is no way a failing manager could use client funds to cover their liabilities. The custodian and regulator will appoint a new manager and funds will continue to be available.