Asset managers are queuing up to launch multi-manager products
Fund of funds is one of the fastest growing sectors in the asset management industry. Asset management companies are queuing up to enter the market, the most recent being Jupiter and Credit Suisse, while within the past few months, ABN Amro purchased Singer & Friedlander's tailored portfolio service.
However, the fund of funds concept has been around for some time. So what has changed that makes this the area of business that everyone suddenly wants to be in?
Companies are having to find alternative ways of protecting their earnings streams, according to Gary Potter, joint head of multi-manager services at Credit Suisse.
Many groups are finding their bottom lines under pressure as investors start to move their money to smaller, more dynamic boutiques with lower overheads.
'If markets are underperforming and a company's big funds are not doing well, asset management companies are being hit with a double whammy,' Potter said. 'It's a combination of wanting to diversify client bases and retain the business a company already has that is providing the impetus to enter this market at the moment.'
In the past, the costs associated with setting up a fund of funds business have deterred many companies from entering the market, Potter claimed. Firms that have provided portfolio services have been able to get away with replicating exposure to desired markets by investing into in-house funds but, he said, customers are no longer willing to accept this.
'Not all in-house funds are good,' Potter said. 'Customers are demanding open architecture and more diversified selections of funds to choose from, particularly in continental Europe, where the concept of diversification has really taken off.'
The possibility of exporting the model to Europe is clearly not one that has been lost on companies that have recently entered the market, or are preparing to.
Another important factor in the surge of industry interest in this segment of the market has been the sheer popularity of the model among intermediaries, many of whom have been grateful to have the burden of asset allocation and the administration that goes with it lifted from their shoulders, said Potter.
Of course, not all fund of funds offerings are constructed in the same way. Investment Week has taken the opportunity to analyse the structure of three of the most popular.
One of the most straightforward forms of the product is that operated by companies such as Edinburgh Portfolio and Jupiter. Investors buy units in a fund of funds, as they would in any other type of unit trust.
The monies invested are distributed into a number of underlying sub-funds, selected by the fund of funds provider according to their prevailing top-down view of the sector in question. Investors, however, hold units in the fund of funds wrapper.
Edinburgh Portfolio has 11 portfolios, all of which invest in different market sectors or geographic areas. Of the 11, four are in the managed sector ' they invest only in funds listed in the active or balanced sectors as defined by Micropal. The remainder invest in geographic specific funds, such as North America.
Each fund of funds portfolio aims to contain enough funds to ensure a diversity of styles and investment processes for investors, while minimising risk exposure. In Edinburgh's case, this would typically be around 25 for a managed fund of funds, and 10 for geographic-specific funds.
The group also selects funds on an unfettered basis, which means it is not bound to invest in internal funds as is the case with some products, although it can, should a particular fund meet the relevant criteria.
At Edinburgh, the mix of funds in each fund of funds offering is regularly monitored and updated by a selection committee that comprises a number of the company's investment professionals, such as Harry Morgan and Paul Talbot.
Director of marketing at Edinburgh Portfolio, Marianne Cantley, said: 'This is not a tailored, discretionary service where you are buying a portfolio of actively managed funds, selected and administered by Edinburgh Portfolio.
'The funds we invest in can all be bought individually by investors, although that would be a much more expensive way of gaining diversity as we are able to buy units at much lower institutional prices because we buy in bulk.'
The company admits there is an element of double charging to this approach. The investor has to pay Edinburgh an initial fee as well as an annual management charge, in addition to a management charge, albeit reduced, for the underlying funds. However, it insists this method of investing is efficient.
Not only do investors benefit from a diverse portfolio of funds at a much lower cost than would otherwise be possible, argued Edinburgh Portfolio's head of research, Craig Heron, but is also a tax efficient way of investing.
Switching between funds within the fund of funds wrapper incurs no capital gains tax liability, unlike switching between funds in a discretionary management service. It also removes the burden of selecting the right fund from the shoulders of busy and unconfident investors.
'In this structure, the actual investor does not pay the extra costs associated with investing in the underlying funds, they are deducted from the fund's returns. The performance figures that are available are net of this deduction,' said Heron.
On Edinburgh Portfolio funds, costs range between 3.25% and 5% for the initial fee, while annual management charges range between 1.5% and 1.75%, depending on the fund. The Edinburgh Portfolio Performance fund of funds, for example, charges 1.75% if its performance is top quartile but less if it drops below.
Heron estimates that the average cost to an investor of investing in the underlying funds is between 0.6% and 0.95% per year. However, he suggests this is more than offset by an estimated 1% annual saving through the avoidance of capital gains tax.
The Jupiter fund of funds service, managed by John Chatfeild-Roberts, is similar in structure but runs three fund of funds: growth, worldwide and income.
Operating on essentially the same basis, Chatfeild-Roberts and his team review their underlying fund mix on a regular basis according to their top-down view.
He said: 'We have a slightly more focused approach than some other providers, with 16 underlying funds in the growth portfolio, 13 in the worldwide and 11 in our income fund. Although there is an extra cost attached to this type of investment, we are able to access funds at a cheaper rate than individual investors.'
Jupiter's initial charge is 5.25%, with 3% available in commission. The annual management charge is 1.5%, of which 50 basis points is payable to intermediaries as trail. The maximum annual management fee paid by Jupiter to underlying fund providers is 75 basis points.
The model used by Rothschild Asset Management (RAM) and Credit Suisse is one that was considered but rejected by Chatfeild-Roberts when drawing up his plans at Jupiter.
RAM, which hired Bambos Hambi from Friends Ivory & Sime to head up the service after Gary Potter, Kelly Prior and Rob Burkett left to join Credit Suisse last year, has nine funds of funds, all of which comprise a cross section of funds from particular geographic regions ' UK, US, Europe, Japan and Asia Pacific ' as well as two fixed income fund of funds ' UK and Global ' and a UK equity income portfolio.
Overlaying this, RAM has six investment strategies: UK Capital Growth, International Capital Growth, Balanced Income & Growth, Income, European Capital Growth and Emerging Markets Capital Growth. These are essentially asset allocation models.
The investor picks an investment strategy, all of which are regularly monitored and updated according to the latest economic data, a process headed up by David Barleggs, RAM's head of asset allocation. The investor's assets are then divided so the asset allocation splits that make up that investment strategy are replicated.
For example, if an investor chooses the International Capital Growth strategy and this calls for a 40% portfolio allocation to the US, then 40% of the investment capital would be invested in the US fund of funds and divided equally between the funds that comprise it.
Head of marketing at RAM, David Orr, believes this system offers an effective way of ensuring that risk is diversified, with each strategy investing in between 30 and 40 funds.
Removing or adding vehicles to the geographic portfolios, in effect buying and selling units, does not trigger a CGT liability, however, as long as it is within the same fund of funds. Switching assets between each fund of funds, altering asset allocations does, although Orr argues this can often be offset against CGT allowances if they have not already been utilised
Orr said: 'Amounts moved in this manner are never huge and rarely amount to more than 2% of assets. This system is not for those who have used their allowance and don't wish to incur further liabilities, which is why we also run a multi-manager service.'
RAM produces annual CGT reports for investors and can often, depending on investment inflows into the service, tilt the strategies without having to sell units in the underlying funds of funds.
Chatfeild-Roberts rejected this system at Jupiter because he believed the scale of diversification inhibited the ability to generate outperformance and made it difficult to generate exposure to specific themes, such as technology.
The annual management charge at RAM is 1.5%, with 50 basis points rebated to the intermediary. The initial fee on a minimum investment of £10,000 is 4%, which decreases on a sliding scale to 3.5% on an investment of £50,000, of which 3% goes to intermediaries as commission.
RAM has been notably aggressive in its pursuit of low management charges from third-party managers and says the cost to investors in its fund of funds model is between 0.6% and 0.7% per year, some of the lowest in the sector.
Credit Suisse's product is similar to the RAM offering, having been set up by former RAM managers Potter and Robert Burdett, although it does feature a different blend of strategies.
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