David (Fuhrman), thank you for a question that speaks to the importance of making a distinction between the possible value that can be captured by embracing the manager sleeve approach versus the ensemble active management (EAM) approach.

The traditional approach of constructing a multi-manager portfolio that is made up of sleeves of individual managers or management teams typically incorporates into each sleeve their full portfolios with their Beta Anchors included. As a result, the Alpha Engines of each sleeve remain diluted by each sleeve's Beta Anchor. EAM combines active the Alpha Engines only (i.e., the high conviction portion or active share of the portfolios) and collapses the sleeves into one portfolio that is made up almost entirely of their active share Alpha Engine names. EAM combines the managers’ Alpha Engines such that the individual manager biases serve as an additional source of diversification, thereby minimizing (or even eliminating in some cases) the need for a Beta Anchor.

Both approaches, EAM and the Beta Anchor, achieve similar results from a risk reduction standpoint. But the traditional approach, employing a Beta Anchor, simultaneously dilutes dramatically the active returns that are otherwise available from the Alpha Engines. EAM preserves the active share returns available in the portfolio and even slightly enhances them through consensus-based diversification. As a result, the active returns that are currently being diluted away by Beta Anchors become available to be delivered to the investor. Using different estimates of the active share of average mutual fund portfolios, we estimate that this dilution wastes 200-300 bp annually.

To be clear, employing the sleeve approach to portfolio construction can often lead to benefits such as reduced risk and diversification by investment style or bias, but this approach pales in comparison to EAM in terms of overall capture of the active share performance available in the undiluted Alpha Engines of the portfolio, while achieving the same or better risk reduction and diversification by style or bias.