If professional researchers and fund selectors struggle to provide value for money, asks Graham Bentley, how likely are model portfolio providers, with fewer resources, to offer more value?
Adviser actively managed model portfolios - and providers' multi-manager multi-asset funds - may not be providing investors with value for money. This uncomfortable implication is one of the less publicised issues raised in the FCA's Asset Management Market Study (MS15/2.2). It is likely to be the subject of a wider review once the final MS15 report is published later in 2017.
The additional charges generated by layers of investment management are a concern for the regulator, with many points of charge leakage along the investment management and advice value chain.
These additional tiers of management purport to add value - ostensibly to deliver additional risk-adjusted returns net of the associated additional fees, through fund selection and or asset allocation. The justification for adding layers of management is the belief there are individuals who can consistently identify future exceptional fund performance.
It is virtually axiomatic no single fund management group can excel across all equity and bond sectors. Consequently, a whole-of-market, ‘unfettered' approach to fund selection appears to make sense. This belief drives platform design towards a whole-of-market approach. A wider pool of available funds means you can build a ‘Real Madrid' portfolio, populated with best fund manager players - the best bond manager, best small cap equity manager and so forth.
Selectivity, however, comes at a cost.
Funds of funds, by definition, exhibit double-charging. That is to say, they have their own ongoing charges figure (OCF) and - currently undisclosed - transaction charges and, in turn, the funds they buy have their own charges.
Some funds of funds are fettered - in other words, the ‘parent' fund only buys funds within its own group. As you might expect, these funds buy their own funds at a hefty discount. Consequently, the headline OCF does not appear too different from a directly invested multi-asset fund.
Many advisers consider these funds to be inferior to their unfettered counterparts. Yet those unfettered funds are investing in the funds of their competitors and, consequently, they do not benefit from the same degree of discount - they have a higher cost as a result.
In the UK, for many years, fund researchers - whether independent or within an adviser practice - have tended to look at their most available fund pool, which would be the Investment Association. There are around 3,600 funds listed, covering the world's equity and bond markets. The value of fund selection today is, however, much harder to demonstrate.
In an information-rich environment, price anomalies are harder to detect. The US market is probably the most efficient, and the data tell us it is the most difficult market from which to extract exceptional, index-beating returns.
The IA North American sector offers 110 funds with a three-year track record. Most of these are managed within one square mile in the City of London. Of those, only two funds (from Old Mutual and Fidelity) have outperformed the index for each of the last three years to 9th March this year. Researchers with limited resources, fishing in this small pool for exceptional performance, are unlikely to add value over an S&P tracker.
According to GAM's head of fund research Kier Boley, the equivalent sector in the US has more than 1000 ‘all cap' funds available. Managers are spread across the US, and not just focused on the East and West coasts. These managers are often ‘under the radar' and, moreover, do not have retail funds available that funds of funds can access.
More puddle than pond
Those businesses with greater resources and assets can negotiate access by persuading these managers to open a retail fund. Businesses with that degree of ‘clout' are the exception. These opportunities are not available to the average adviser and discretionary fund manager (DFM). Their fishing area is rather more puddle than pool.
Analysis of the UK multi-manager, multi-asset sector exposes this starkly. Bearing in mind these asset manager fund selectors are the pick of the crop, it is disappointing to note that on a risk-adjusted, ‘like-for-like' basis, passive versions of these fund ranges tend to provide higher returns per unit of risk.
Perhaps more surprisingly, where the stables further include both fettered and unfettered ranges, unfettered versions are statistically no more likely to outperform than the cheaper fettered versions. In 2016, 75% of these ranges saw superior returns from fettered versions versus multi-manager. Over five years, on average the degree of superiority was around the same figure.
Actively managed multi-asset funds were on average 0.26% more expensive than their fettered cousins. This underlines the impact and importance of costs and begs the question - are unfettered funds or portfolios worth paying for? Do these full-time selectors exhibit skill that provides value for money relative to that additional charge?
Most starkly, if ‘professional' researchers and fund selectors struggle to provide value for money, how likely are advisers, with limited resources, to provide more value while adding yet more costs? The DFM and advisory model portfolio industry may have its work cut out to persuade the regulator otherwise …
Graham Bentley is managing director of investment consultancy gbi2. You can read more of his columns here
Analysing ‘noise’ largely pointless
For advisers and clients
Responds to FCA study
Performance and fees two sides of same coin
‘Auto-drawdown' and ‘auto-annuitisation'