A new breed of managed funds is competing to take over where with-profits left off but what is the difference between each one and which type of product will capture the interest of the former with-profits investors?
Managed funds mean different things to different people. Their most common guise is as the steady-as-you-go with-profits equivalent, offering a blend of bonds, equity and cash for investors lacking either the cash or the inclination to do their own asset allocation. But competing with this type of fund are also fund of funds (both fettered and unfetterred), manager of managers and distribution funds. All are vying to pick up where the with-profits market has left off and grab some of the spoils. What distinguishes each approach, both from each other and from with-profits? And which approach looks set to win the hearts of the former with-profits investor?
Automatic rebalancing is a crucial difference between the modern managed fund and the old with-profits fund. It is no secret that the asset allocation of the majority of with-profits funds has changed. The MultiManager survey in December found that the average with-profits fund now holds nearly 50% in fixed interest, with 35% in UK equities and the remainder in either cash, overseas equity, property or alternatives. This asset allocation has changed substantially over the past six years as fixed interest and equity markets have risen and fallen respectively, meaning with-profits funds are always holding the maximum amount in the asset class that has performed best. And, of course, the subsequent direction of the top-performing asset class is usually all too clear.
All the new breed of managed funds avoid this problem with many sticking to a constant asset allocation or others taking asset allocation decisions along the way. Few are still taking asset allocation decisions based on 'drift' or to keep up solvency requirements (as too often life companies have made asset allocation decisions based on their solvency rather than for sound investment reasons). The FSA has stated its support for rebalancing, mainly in response to the with-profits situation.
Distribution funds were initially hailed as the most obvious successor to with-profits. They were designed to have a tax advantage for income investors, but some have found the investment impact of the restrictions outweigh the tax advantages to be gained. Equity exposure needs to be limited to 40% in order to maintain the advantageous tax status. The average asset allocation is 47% fixed interest, 38% equity and the remainder in cash, equity and alternatives. But this masks a myriad of different approaches. Prudential Distribution, for example, holds around 55% in equities, while Invesco Perpetual Distribution holds nearly 60% in fixed interest and just 25% in equities.
The grandfather of distribution funds is Axa Distribution, managed by Jim Stride. He runs the fund with up to 60% in equities. At the moment the fund is 55% invested in UK equities, 35% in index-linked gilts, 7% in fixed interest and 3% in cash. Stride says: "We have relatively consistent asset allocation. This has meant that we were forced to sell equities after they had had a fabulous run and reinvest in equities at the end of 2002 when the equity market was flat on its back, as our equity position had dropped sharply. It acts like an inbuilt stabiliser."
As with many distribution funds, there is an overall manager looking after the asset allocation, while other parts are outsourced to different teams within the group. Stride also looks after the equity selection, but leaves it to Axa's bond team to select the fixed interest holdings. The equity portion is largely blue-chip. As to whether distribution funds should be the main alternative to with-profits, Stride says: "These funds tend to have a consistent balanced asset mix and they are much more transparent. Investors need to understand the merits and demerits."
The fund of funds market tends to divide into three camps. The first, as adopted by Skandia or many of the manager of manager groups, uses no active asset allocation, but rebalances to a set benchmark. This benchmark may be a sector average (as in Skandia's case) or one devised by the company. The second is used by the majority of well-known fund of fund houses, such as Gartmore, Credit Suisse, F&C and Insight. These groups take small asset allocation bets a few percentage points above and below the benchmark. In Gartmore's case, the team is advised on asset allocation by an internal expert. Others use a consensus of the major investment houses. The third camp is that used by, among others, New Star, Jupiter and Miton. These groups take active asset allocation bets and will move in and out of funds as they see the market changing. This latter approach has tended to produce the best performance. Some will argue that it is done at the price of higher risk, but this is not borne out by volatility figures.
This market is expanding and diversifying. Fidelity launched its three Target funds last year. These funds have five, 10 and 15 year time horizons and alter the asset allocation towards less risky assets as the time expires. Manager Richard Skelt developed the model in combination with consulting actuaries and academics and only deviates from that model occasionally in response to shorter-term market movements. Investors therefore do not have to buy and sell funds to ensure their changing asset allocation needs are being met as they get older. Skelt says: "If you go to the States, this type of fund is a default option for the 401K schemes. It is the most appropriate vehicle."
US group Hartford has recently brought its offering to the UK, aiming to fill the gap left by with-profits. The concept is similar to multi-manager, but the group offers its 'Safety Net'. Investors pay an additional 0.5% for a full money-back guarantee. This is not backed by derivatives as many guarantees have been, but by company reserves. The group has links with Fidelity, Invesco Perpetual, New Star, Schroders and Investec. Its Gold portfolios offer five different asset allocation mixes (advised by Ibbotson Associates) ranging from Income to Adventurous Growth. Investors can switch between the portfolios without cost as their investment needs change.
The traditional managed funds offering a blend of direct investments (typically equities, fixed interest and cash) are still around but many have been discredited by mediocre performance. Many were offered by the life offices where investment performance has been weak. That said, some groups have managed to do it well. One of the top performers has been Neptune's Managed fund. Manager Robin Geffen runs it with an absolute return mandate. It is a multi-asset class portfolio with no minimum level of equity and Geffen will go into short-term paper or bank deposits, if he is bearish on the market.
Alastair Mundy's Investec Cautious Managed fund has also been popular among fund of funds' managers and advisers. Mundy takes a 'deep value' approach seeking out stocks that have reached rock bottom. His portfolio currently has an asset allocation split of 58.8% equity, 36% bonds with the remainder in cash and alternatives. It takes a highly skilled manager to make this approach work and Mundy has been one of the most successful.
All of these approaches are suitable to succeed with-profits. Multi-manager has been flavour of the month for some time because it is easy to understand and advisers have felt comfortable with the familiar names that run the funds. But it is likely to see more of a challenge as more innovative products arrive on the market - witness the multi-asset class portfolios that include alternatives that are now becoming available. Advisers have increasing choice in this area of the market and no longer have to be content with weak with-profits funds for a one-stop shop solution.
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