Head of research at OBSR Richard Romer-Lee kicks off proceedings by looking at the state of the multi-manager market
"The nice people at RealAdviser have asked me to speak on the daunting subject of the state of the nation regarding multi-manager and fund of funds. So I am going to try and paint a picture of how we see this very exciting market, where it has got to and where the fund management companies are taking it.
I want to focus on the growth of the market - because it is growing and it is growing fast. Then I want to spend some time looking at how the funds are doing and I will draw briefly on some trends and some innovation. And then, so you can get the first kip of the day, I will talk a bit about new regulation. You are going to need to know what your funds can do from next year, so I regret I have to visit the world of Nurs and Ucits III.
The arguments for using fund of funds and multi-manager are well-versed so I don't propose to go over them again but how much money is invested in multi-manager in the UK? Lots of people try and come up with a figure - we reckon it's somewhere around £50bn - but it does change a lot. So what I will concentrate on is the growth in the market. That's inflows into multi-manager - net new business.
We reckon something like £5.8bn went into the asset class last year. To put that into context, the whole mutual market is probably worth about £350bn and the life and pensions market well over a trillion. So £5.8bn is significant but there is a long way it can go.
What is interesting is that the amount of money going into fund of funds has accelerated in the UK, almost doubling each year for the last three years, which bears out some of the well-discussed arguments for fund of funds. There are a number of factors influencing this asset-gathering - the key players have got big distribution, they are listening to their clients and they are generating some good returns.
I want to talk about performance because ultimately that is what matters but it is always really important to assess a fund manager against what he or she is trying to achieve. However, I do not think the IMA or the ABI go far enough in dividing sectors to make those comparisons really meaningful. So you must look at each objective.
The Active, Balanced and Cautious universes mask different approaches and it is really important people think about what a fund of funds is offering. We break it down into three groups, the first being those who are seeking to add value from active asset allocation as well as from fund selection.
The second group are a bit more traditional - they try and add the majority of value from fund selection, going back to the belief that not every single fund management group is good across the board. So they want to pick the best-of-breed in each area, in each asset class and in each market. But they will try and add a little bit from active asset allocation.
The third group - and this is where I think most of the manager of managers fit - is where there is fixed asset allocation. So they are letting the adviser determine the asset allocation - they have got no intention of adding any value from asset allocation and they are going to try and eke a little bit of outperformance from the manager selection.
So there is a grey area in the whole fund of funds world as to how much of the asset allocation an adviser is outsourcing. Are you outsourcing it all? Or are you keeping it yourself? As a result of this grey area, the fund of funds market is trying to operate - or offer - different solutions.
I now want to talk about trends and innovation in the markets. These show how exciting the market is becoming and the opportunities that arise. For example, we have the best ideas funds - and I am referring particularly to Skandia, which launched a global best ideas fund about nine months ago. It was simple - 50% in the UK, 50% overseas and giving 10 managers the ability to pick 10 stocks.
Some of you might ask where this fits into client portfolios and that is a very good question. But Skandia raised £170m in the fund in nine months, which is a staggering amount of money. It is also launching a UK best ideas fund and its expectation there is £75m in the first three months. There is a lot of money going into this asset class.
A second area where we have seen developments is with absolute return or target return, where people are beginning to design different types of funds that target Libor plus a certain amount. We have already seen Insight bring the Diversified Target Return fund out but I suspect - I know - there is a lot more of that to come. So fund groups are starting to broaden the range of solutions adviser clients are looking for.
The changed regulations permit more asset classes to come in as well so, increasingly, we are seeing property coming into fund of funds. We are seeing funds of hedge funds. We are seeing private equity. So there is further diversification in what these managers are prepared to invest in for the benefit of customers. I expect that to continue as well.
To emphasise how important the fund of funds world is to individual companies, Fidelity has thrown its weight behind fund of funds - with its global platform, analysts all over the world, big distribution. Already it has got more than £10bn under management in fund of funds - a staggering amount and it has not really started yet.
Then there's HSBC, which had a fairly reasonable UK equity capability - not the best, but if you are not the best you are struggling to compete. So it has basically changed the mandate for three of its funds. The fund manager has gone and HSBC is going to go through a manager of manager approach with £2.2bn. I suspect we will see more of that as competition hots up.
Now for the tricky bit. As I am sure you are aware, there are new Ucits III and Nurs rules being introduced next year to replace the collective investment scheme source book. This is referred to as Coll, is part of the FSA handbook and will provide the framework within which authorised funds must operate. It comes into play from 13 February 2007 and all firms operating schemes under the old collective investment schemes source book must move to Coll.
I think there are a number of misconceptions surrounding Ucits III funds. For example, some people believe that, when these funds come into being, managers immediately start tucking into derivatives and the extra powers available to them. But that is absolutely not the case - most people are going to be very cautious. This is a new world for them and these are new skills for a lot of companies. However, some Ucits III funds will use derivatives more aggressively and that brings a whole load of different questions advisers are going to have to ask fund managers.
In order to convert to Ucits III, fund management groups have to submit details of their risk management processes to the FSA. This is a new dimension of risk - these are new instruments people are using and so you have got to be sure they understand how they are going to take risks. We have talked to some funds and it has taken up to two years for them to put systems in to operate these relatively simple derivatives packages.
Now fund of funds are going to help because you are going to have fund professionals analysing these other managers to make sure they know how they are using these funds. But it is an extra layer of responsibility for the fund of funds manager. And there is also an extra layer of responsibility for advisers when they are looking at the funds they are investing in.
According to the new rules, when a fund manager is using derivatives he must employ a risk management system to monitor the risk of all the derivative positions and notify the FSA. Whether or not they are going to keep up with that is another matter but that is what they must do. And it is not really clear to everybody how this might develop so there is a certain amount of caution here.
From a fund of funds perspective, some funds have elected to be Ucits III, some have elected to be Nurs. The powers are broadly similar except Nurs funds will include all types of retail collective investment schemes that are not Ucits III. Their powers are wider - they may invest in gold and also direct property, which is interesting for people who want to launch property funds.
They are allowed 20% in non-approved securities such as unregulated funds, as opposed to only 10% under Ucits III. They are allowed to borrow up to 10% permanently whereas that can only be temporary under Ucits III. There are also rules about exposures to counter-parties and the over-the-counter market because a lot of derivatives are traded there.
Nurs funds can also price less frequently although I do not expect many of the ones offered through intermediaries to be like that. But, critically, different companies have elected to do different things. So some will stay plain vanilla, some will go a certain way and start using new asset classes and some will go much further. I expect to see much more innovation here. It is a bit complicated and not very exciting but do make sure you know what option your fund manager has taken and what they plan to do.
So the market is growing and all the arguments of the last few years as to the benefits to intermediaries of fund of funds are being borne out - not only in business flows but also in the innovation and the resources fund management groups are putting behind this sector."
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