Off The Peg:
Posted on: 07 Jun 2012 by James Farmer

Fund-of-funds offer a ready made solution for client portfolios, says Nick Sudbury.

 

You won’t exactly need reminding that the last decade has been one of the most turbulent in living memory, with investors enduring a succession of sharp stock market crashes and protracted recoveries. Or that complex policy responses like quantitative easing have added to the confusion and made it difficult for any mere mortal to know where he ought to invest.

 

Against this backdrop, then, it’s perhaps not too surprising that the one area of the market that has grown consistently is the fund-of-funds sector. (Otherwise known as multi-manager.) And what a growth curve it’s been. At the end of 2002 these investments accounted for a mere £21 billion of assets under management – but ten years on, the figure has risen to almost £96 billion. Indeed, the Mixed Investment 20% to 60% Shares category has headed the retail client best seller list in 5 of the last 7 years.

 

From a client perspective, the beauty of investing in a fund-of-funds is that it enables him, in effect, to delegate the whole process to a seasoned professional. This means that he no longer needs to select which funds to buy, or worry about how to combine them into an effective portfolio. Better still, he won’t need to lose any sleep if something happens or the market changes, because he knows his manager will react accordingly.

 

 

There are also attractions from the adviser’s point of view. A successful fund-of-funds could potentially provide a ready-made solution to the post-RDR challenge of delivering best advice from across the many thousands of funds available in the market. The task of deciding which products would be most suitable for a given client has suddenly become a lot more manageable.

 

So much for convenience, then. But what about performance?

 

Well, the Mixed Investment 20% to 60% Shares category has generated an average return of just 46.2% over the last decade, which doesn’t sound so great until you compare it with the Footsie’s very turbulent ride to a 15% gain. (Although the Footsie figure should properly receive an additional sum for dividends, obviously.)This relatively modest growth rate has been partly down to the extra cost, of course. But actually the better managers have more than made up for the double layers of fees.

 

It is also striking how much variation there is in the spread of the underlying portfolios. Some multi-managers make a virtue of diversification and hold 20 or even 30 different funds, while others concentrate their money in just half that number. So who’s getting it right? Well, one obvious problem with investing in too many funds is that you can diversify away all of the alpha and end up with a very expensive quasi tracker fund.

 

A Bit of Magic from Merlin

One of the most popular products in the sector is the range of four fund-of-funds known collectively as the Jupiter Merlin Portfolios. These each cater for a different investment objective, but are managed by the same experienced team headed up by John Chatfeild-Roberts.

 

The largest of the four is the £3.5bn Jupiter Merlin Income Portfolio. This aims to achieve a high and rising level of income with the potential for capital growth. The underlying funds mainly consist of UK-based, income generating investments, with up to 60% in equities and the majority of the balance in fixed interest.

 

Algy Smith-Maxwell, one of the co-managers at Jupiter, says that a fund-of-funds is an appropriate and versatile structure that allows them to combine a top down macro strategy with bottom up fund selection. “We spend our time analysing managers and markets, then back our convictions,” he says. “Historically, around 50% of the portfolio has been invested in the top 5 holdings.”

 

Jupiter Merlin Income has built up an amazing track record with a return of 108.6% since the current team came together in 2000. It has a concentrated portfolio of just 13 funds and historically yields 2.8% with the dividends paid on a quarterly basis.

 

Smith-Maxwell says that the team’s overall aim is to increase the real value of its investors’ wealth over time. And, to do that in a logical way, you have to minimise the downside.

 

“The vast majority of the managers that we invest in have to have a consistent strategy, and to have made money through an entire economic cycle. They are typically willing to underperform in a bull market as long as they don’t underperform in a bear market.”

 

The people Jupiter have money with reads like a Who’s Who of the industry, with the roll call including the likes of Neil Woodford, Adrian Frost and Richard Woolnough. As a result, the rolling 3 year performance results have always ranked in the top quartile.

 

Nice Little Earner

Legal & General is perhaps best known for its index trackers, but the company also has a range of three fund-of-funds – an income, a growth and a balanced mandate fund. These have the freedom to invest in managers from across the industry, as well as in their own in-house products.

 

Of the three, the largest is the L&G Multi-Manager Income Trust with assets under management of £245m. This has returned 45% in the last 3 years, and it has a historic yield of 2.7%. Considering the dual-layered nature of the fund, it has a very reasonable TER of 1.8% – although there is also a performance fee that applies in certain conditions.

 

Tim Gardner, one of the co-managers, says that the team uses active asset allocation and fund selection to add value via both disciplines. “In our view multi-asset doesn’t mean holding all asset classes at all times,” he says. “We look at the fundamental drivers of return, and then react accordingly.”

 

The Income Trust currently invests in 18 separate underlying funds, including highly regarded products such as M&G Optimal Income, Invesco Perpetual High Income, Artemis Income and M&G Recovery. Its largest geographic exposure is the UK, with a weighting of 28%, followed by the US at 14% and Europe at 9%.

 

The main focus, Gardner says, is on qualitative research which enables the team to assess the decision-making process. That will entail looking at various factors, such as who is generating the investment ideas, the remuneration structure, and also the capability of the organisation to support the fund. “We think it is very important to meet the managers face to face so that we can understand the investment process and whether it is repeatable in the future,” explains Gardner.

 

One Stop Shop

The Witan investment trust was established way back in 1909 and is now worth over £1.2 billion. It has been using an independent multi-manager approach since 2004, with the underlying portfolio having a minimum 80% exposure to world equity markets. The strategy has resulted in the share price increasing by 67% in the last 10 years.

 

“The multi-manager approach enables the trust to appoint a number of specialist fund managers, with specialist abilities in an individual area, with the aim of reducing individual manager risk and hence enhancing returns for the Trust’s shareholders,” explains Andrew Bell, CEO of Witan. And sure enough, the fund has no less than 11 separate managers as well as a segregated portfolio of direct holdings. The present incumbents include respected firms such as Artemis, Veritas and Lindsell Train, as well as specialists like Trilogy who run the Emerging Markets exposure.

 

Bell argues that the investment trust structure has three main advantages over an open-ended fund-of-funds. The first, he says, is the cost. Witan’s TER last year was just 0.87%, which compares well with many of the big retail open-ended multi-managed funds costing 2% or more.

 

He also explains that the Trust is able to gear the portfolio to take advantage of rising markets and can use its accumulated dividend reserves to support future dividend growth. This has enabled it to increase the payout in each of the last 37 years.

 

Tailor Made

One of the toughest challenges facing advisers is to come up with a decent portfolio that matches the clients’ objectives and attitudes to risk. If anything this is going to become even more problematic post RDR, when the fund selection process will necessarily have to take into account the full range of options from across the market.

 

Russell Investments is one of a growing number which aim to meet the challenges of RDR by providing products that will allow advisers to create their own customised investment solutions that can accurately reflect their clients’ objectives. By starting out with a series of model portfolios, and then adding further tailoring to suit the individual’s personal circumstances, they aim to deliver maximum flexibility without overstretching the adviser.

 

“Advisers’ time is limited,” explains Russell’s Greg Stark, “and they are naturally keen to make sure they can provide the best possible value for their clients. We are finding that more and more advisers are now turning to outsourced investment propositions – and especially to the ones that are highly customisable.”

 

Like Legal & General, Russell believes that the only effective selection method is to meet the managers in person. “Asset management is a people-orientated business,” says Stark, “and we do not believe it is possible to identify those managers more likely to perform well without meeting with them – not just once but on numerous occasions – and also with everyone else within the firm who is important to the investment process,”.

 

It’s quite an undertaking. Russell has 200 investment professionals in its multi-manager team, who set up and conduct around 4,400 manager meetings a year all over the world. Only in this way, he says, can the company narrow down the tens of thousands of products available to the much smaller number that it eventually uses.

 

There’s little doubt that, with so much consumer uncertainty still out there, the demand for funds of funds will continue to grow exponentially. “RDR represents a great opportunity for the investment trust sector to expand its appeal to the adviser market,” stresses Witan’s Bell. “We expect this to lead to increased interest in those trusts which can deliver good investment returns at a competitive cost, while also addressing concerns over dealing liquidity and discount management.”

 

 

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