While there is now an almost limitless universe of funds to choose from and fund managers are free to operate throughout the EU, regulation has made the advisers' job increasingly complicated
The role of the fund picker has come a long way over the past 15 years and never more dramatically than in the last three years with the advent of Ucits III. The job of balancing a range of investment assets on behalf of clients and ensuring they match their investment and risk attitudes has become increasingly complicated.
Firstly, with an investment universe of 2,000 unit trusts and some 18,500 offshore funds, selecting the right balance of funds is no small feat. Secondly, the introduction of Ucits III has blurred the lines drawn between one asset class and another, or even one fund and another. This has added another layer of complexity to the job of fund selection.
Outsourcing fund selection
Faced with this almost limitless choice of funds and understanding the implications of Ucits III, the intermediary, in particular, also has to contend with the introduction of practices such as best advice, 'reasons why' letters and treating customers fairly. The advisers due diligence process takes twice as long as it did 10 years ago and requires constant reassessment.
Weighed down with these regulatory pressures and steeped in administration work, an increasing number of advisers are handing over the job of fund selection to multi-managers. This frees up significant time for the adviser to spend face-to-face with the client and provide a bespoke service for their wider financial needs, for example, pension planning, saving for their children and acquiring a mortgage for a second home.
What you see is not always what you get
Some 12 years ago, a fund did exactly what it said on the tin. But, with the introduction of Ucits III and more recently Nurs (non-Ucits retail schemes), the investment powers of fund managers have widened. Now what you see is not always what you get.
Fund managers now have the freedom to operate throughout the EU and invest in a wider range of financial instruments. Among other things, they are allowed to use short-term borrowing, adopt hedging techniques through the use of derivatives and take currency positions. But, perhaps most crucially, these new rules have allowed fund managers to become much more aggressive in their asset allocation and in their cash weightings.
Previously, Investment Management Association (IMA) guidelines protected what a fund could do, enforcing rules as to the maximum cash and equity weightings allowed. But funds such as Threadneedle Accelerando, which invests in the UK and was among the first to adopt Ucits III, can now either be 100% invested or have 100% of its portfolio in cash. As a result, this fund, which ordinarily would sit in the IMA UK All Companies sector, has moved to the 'unclassified' grouping of funds since it has become very difficult to keep track of what it is doing.
As a fund picker, basing your investment decisions on the IMA sector guidelines alone is no longer viable. With its investment remit significantly widened, even two funds in the same sector will often use very different techniques and thus generate very different returns.
Another consideration for fund pickers is many of these new freedoms could raise the risk profile of the funds. Within the Cautious Managed sector for example, different funds might display very different levels of volatility. A fund picker managing a portfolio for risk-averse clients needs to scratch below the surface to see if the underlying techniques being employed are in line with the client's attitude to risk. They also need to constantly monitor the funds for any changes that may impact the risk profile of the portfolio.
As the funds within the unclassified sector grow, at some stage it will become unmanageable and, going forward, the IMA is likely to have to change the way it classifies funds.
One area that remains sceptical is the emergence of absolute return bond funds under Ucits III, this will continue to be misleading for investors. For example, an investor who thought he had bought into a global bond fund could easily be investing in a duration fund, which uses hedging techniques to go long or short.
These funds do not offer an income, so income-seeking investors would have to sell their capital in order to generate an income. This in turn would get added to their capital gains tax allowance for the year rather than their income tax allowance.
closer to the action
Nowadays, a fund picker has to be much closer to the action to know what is going on. Fund of funds managers have the time and the resources to closely monitor their funds as well as meet their management on a regular basis. They also have the ability to invest in funds with high minimum investment barriers, which would otherwise be off-limits to most retail investors.
According to statistics from the IMA, funds under management in the funds of funds arena grew from some £15bn in 2004, to £23.4bn in 2005. This rose to £25.7bn in the second quarter of this year.
Nevertheless, the multi-manager model itself is changing. Multi-managers have also had their investment remit widened by Ucits III and Nurs. Where previously fund of funds managers were restricted to a simple asset allocation call, Ucits III and Nurs have given them greater powers to buy and sell what they want, including the use of property as an asset class, and the use of derivatives, hedge funds and structured products.
Another area that has experienced change is multi-asset strategies, which has seen a rise in the number of products being offered. Managers such as Midas are investing directly in equities alongside structured products, protection, properties and funds. This model is closer to a portfolio construction service that an adviser might offer than a fund of funds.
Skandia, on the other hand, has launched best ideas funds, where it dictates to a selection of top-performing managers the portfolio it wants them to construct and manage as a separate segregated mandate to its retail unit trust. Skandia then manages the asset allocation between the selected group of managers. This model has been used by institutional clients for some time, but Skandia has gone a step further and created a hybrid model that invests in funds as well as manager of managers.
The future of asset allocation
Some investors wrongly believe that if they track the FTSE 100 they will achieve a diversified portfolio of assets. However, if you consider that the top-10 stocks in the index - which are dominated by oil companies and banks - account for some 50% of the index, then your diversification is seriously limited.
Yet, the argument investors ought to be looking at much more active managers is also fraught with obstacles. Namely regulation, a vast investment universe with an increasing number of international funds selling in the UK and the extended powers convened on managers by Ucits III and Nurs.
Faced with all these issues, intermediaries can be forgiven for feeling a little overwhelmed. Fund of funds can provide a solution. But do not be fooled - more than ever before, fund of funds managers have their work cut out. Regular due diligence on every fund, technique used and fund manager is vital in order to meet investors' expectations and keep ahead of the competition.key points
Ucits III & Nurs regulations made it more difficult for funds to fit into categories
Fund pickers can no longer look at just categories
Regular due diligence needed on every fund to meet investor expectations
Partner Insight Video: Advisers have had to adapt to the changing investment landscape.
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