Unfettered funds of funds would seem preferable to the fettered variant for giving superior performance but the split is not so clear cut
Given their greater freedom, unfettered funds of funds, it can be argued, should outperform their in-house fettered peers.
Not everyone agrees, including Fidelity, which continues to run with fettered products such as its Wealthbuilder fund managed by Richard Skelt.
Investment Week's sister publication, MultiManager, examines the pros and cons of fettered and unfettered funds to see which have produced the best returns. The survey examines what factors go into producing returns in funds of funds, including not only picking the underlying holdings but also asset allocation, style blend and risk controls.
Fettered products appear to have the advantage of cost, usually cheaper by around 0.5% per annum. Because of their lower charges a key question is whether their unfettered rivals can provide the outperformance to more than compensate for this.
'Fettered funds have the advantage of wiping out double charging,' said Peter Hargreaves, chairman of Hargreaves Lansdown, 'but this is only going to save you half a percent.'
Paul Wilcox, chairman of Way Fund Managers, said: 'You won't get the same discount on unfettered as you can get on fettered funds but frankly you are talking about half a percent. If you can't compensate for this via performance you need to be shot.'
Hargreaves said: 'Fettered funds of funds haven't got a prayer of being the best. If that wasn't the case, why would groups like Hendersons and Jupiter go down the unfettered route? The only way fettered funds of funds could do better than unfettered is to take bets against the market, for example to go massively overweight value in the US.'
Stuart Holah, executive director at Fidelity Investments, challenges this view. He said the company is often frustrated by the view that unfettered funds of funds must be better than fettered. 'There has been this orthodoxy that unfettered is better but we don't believe that,' said Holah. 'There is good and bad in both approaches, but both share the same basic goal of managing risk and delivering returns. There is a generic advantage of funds of funds over single manager funds that enable good ones of whatever flavour to be successful.'
A look at the performance statistics for the cautious managed, balanced managed and active managed sectors reveals that in each one the best-performing fund of funds over five years is unfettered.
In the active managed sector, the fund of funds with the best performance record over the five years to 14 October 2002 is Edinburgh Portfolio's Performance Portfolio A, which returned 2.22%. In the cautious managed sector it is Jupiter's Merlin Income Portfolio, which returned 9.59% and in balanced managed, the AS Miton Strategic Growth, which came top with 12.3%.
The second best performer in balanced managed is Edinburgh Portfolio's Fund of Funds. But unfettered funds do not have it all their own way. The third best performer in the sector over the period is a fettered product, the Fidelity Portfolio, which returned '0.59%. Holah believes figures like this mean Fidelity is justified in maintaining its fettered approach.
He said: 'The record speaks for itself. Our funds look very strong on a risk adjusted return basis. We also have a record of moving quickly to successfully address fund performance issues.'
In the UK equity & bond income sector, though, a different story emerges. The fettered Scottish Widows Selector Income A fund has the best record of fund of funds over five years, returning '3.71%. The Edinburgh Monthly Income Portfolio currently only has a two-year track record but has topped the sector rankings in both years.
The UK equity income sector contains only two funds of funds, neither of which has a five-year track record. Artemis MultiManager UK Equity portfolio has only been running since February, while the Credit Suisse MultiManager UK Income portfolio ranks 35 out of the 82 funds in the sector, having returned '19.08% for the year to 14 October 2002.
But the split between what constitutes fettered and unfettered funds is not quite as clear cut as it looks. Some fund of fund managers, for example, have an asset allocation model imposed on them, meaning they do not have a completely free hand when it comes to choosing which funds make up a portfolio.
Martyn Ingram, research director at Investors Partnership, said unfettered funds of funds have a big advantage in that they have access to the best fund managers in the world. 'Some groups, though, who claim to be unfettered exclude their own in-house funds, which is a shame,' he noted.
A number of groups impose restrictions on fund of funds managers, preventing them from using in-house funds. It is understandable the group wants to appear to be completely unbiased in its choice of funds but this also introduces the possibility of ignoring the best fund in a particular sector simply because it happens to be in-house.
'I particularly like Aidan Kearney at Artemis,' said Ingram. 'He offers true unfettered funds of funds. He is his own man and will make his own decisions. You tend to find others can be constrained.'
Ingram points out that some groups do not have the option of offering fettered funds of funds because of their relatively small size. UBS, for example, only has a small retail fund offering and is therefore unlikely to want to offer a fettered fund of funds because of this. Others, such as Fidelity and DWS Investments, formerly Deutsche Asset Management, have a large range of in-house funds and are confident they can achieve sufficient diversification using only these.
Jonathan Arthur, who manages the DWS Managed Portfolio fund, its fettered fund of funds, said: 'I have access to key flagship funds and I also have the advantage that I know all the managers.'
The statistics appear to bear this out to some extent as the fund has outperformed many of its unfettered peers in the balanced managed sector. DWS closed its two unfettered funds of funds in September.
M&G has assets of £1.5bn in its fettered funds of funds. In January it is to launch an unfettered version and has outsourced management of the portfolios to Cazenove.
Phil Wagstaff, managing director for UK retail at M&G, said: 'We will continue to offer fettered funds of funds. We see the unfettered funds as enhancing our product range, and there are arguments for both. It is a question of filling the product range with what people want.'
Fettered funds of funds do have some advantages over unfettered, particularly with regard to monitoring the underlying managers.
'The greatest strength of fettered funds of funds is risk control,' said Ingram. 'The manager is fully aware of what underlying managers are doing, and often has access to live portfolios.'
Wilcox reinforces this view, adding: 'Of course there are benefits to being fettered. Fund of fund managers know the managers and processes far more intimately.' Wagstaff agrees: 'Fettered is cheaper, and therefore can give an advantage. The in-house manager has inside knowledge of what underlying managers are doing.'
Holah conceded that the argument of unfettered funds of funds having access to a far wider universe is a valid one but this must be balanced with the availability of in-house information on funds and managers' strategies.
'Richard Skelt, who manages the Fidelity Portfolio, says that what makes his job easy is the close proximity of in-house managers. Whatever levels of disclosure unfettered groups have, they could never quite match this,' said Holah.
'That has to trade off against the size of the universe, although we are in the unusual and fortunate position of having a breadth of funds ranging across all sectors and a diversity of fund styles within those sectors.'
Ingram also noted the importance of asset allocation on the performance of a portfolio. 'If a group offering fettered fund of funds has excellent performance it can be attractive. Even if if has some poor performing funds, a lot is driven by the asset allocation model,' he said.
Hargreaves pointed out that no asset management group is remotely close to having the best manager in every sector. He said: 'The most any group could claim to have is maybe the best managers in three of 18 sectors.'
Wilcox agrees: 'One investment house does not have a monopoly on sectors. You cannot make your in-house American manager, for example, better than he is.' He also noted that if a star manager leaves a group that only uses fettered funds, it does not have the option of following that manager.
Holah conceded no group, Fidelity included, can claim to have the best fund in every sector but he does not believe this to be a problem. He said: 'You don't need to have the absolute best funds, it's about the synthetic blend.'
Fidelity's house style on constructing fettered portfolios is to pick funds that will work well together and provide a blend. 'If you look, for example, at our Income Plus and Special Situations funds, when blended together they give significantly different characteristics from the individual funds,' he said.
M&G is a firm believer that running fettered and unfettered funds are different skill sets, as evidenced by its decision to outsource the latter product to Cazenove.
'Picking unfettered funds is not a part-time hobby, and we don't have the skills to do it in-house,' said Wagstaff. He added that M&G has not imposed any restrictions on portfolio construction and the decision on whether to use M&G funds rests entirely with Cazenove. 'We decided that the investment manager needs to make the call,' stressed Wagstaff.
Even Way Fund Managers has outsourced its portfolios to IMS. Wilcox said: 'If you employ research and selection people, as we do with IMS, they could not cope with being hampered by selecting funds from only one house.'
Ingram believes it is not simply a question of whether fettered or unfettered is better, but of looking at the quality of each individual offering.
'Ultimately one must look at the team providing the service and ask whether it is experienced in this area of the marketplace,' Ingram said.
'Many advisers use fettered and unfettered funds of funds alongside each other. I think this is enlightened thinking on their part,' added Holah.
Wagstaff said: 'There is no conclusive proof that one type is better than the other.' He noted demand for unfettered product is being driven by intermediaries, who feel it is a more attractive option to offer to their clients.
Fidelity does not have a philosophical hang-up on using fettered funds, said Holah, and is constantly looking at whether to use unfettered funds. He added: 'We could include unfettered funds to complement our offering. There are no immediate plans to do this though.'
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