Advisers may now have significantly more choice when it comes to investment outsourcing but, says Cherry Reynard, this makes it even more crucial they ensure they are not settling for mediocrity
Financial investment advice on investment outsourcing
The growth of the managed solutions sector continues apace but, although many discretionary managers, fund of funds and multi-asset groups are still merrily making hay, a number of threats loom on the horizon. Regulatory scrutiny may force greater transparency on fees, for example, while a lack of differentiation between providers could raise consumers’ hackles. At the same time, performance measurement is becoming more sophisticated and competition fiercer – all of which means advisers need to know their outsourced partners better than ever.
There can be little doubt the market for managed solutions remains buoyant. To pick just two examples, St James’s Place enjoyed new inflows of £1.2bn in the first three months of this year – up 26% on the same period in 2013 – while, as of the end of March, Brewin Dolphin had seen total discretionary funds under management grow to £22.7bn, compared with £21.3bn six months previously, and £20.4bn a year ago.
"Where Adviser-Hub’s own users use discretionary fund managers, it is usually through long-standing, trusted partnerships and where the manager brings something different for their clients."
Equally, fund of fund providers continue to grow assets and market share. According to the Investment Management Association, net retail sales of funds of funds in April were £520m – the highest level since April 2012. This was split £370m to unfettered funds and £150m to fettered funds. As of the end of April 2014, the sector as a whole was worth £91bn – equivalent to 11.5% of industry funds under management and up from 11.3% a year earlier.
The platforms also report strong sales of managed solutions – for example, Novia recently confirmed discretionary managers have formed the lion's share of its flows since the start of the year. The group now offers 42 different options, including an in-house range via Copia Capital Management. On Skandia's platform, multi-asset funds made up 32% of all net sales in the first quarter of the year while, in the last month of the Isa season, four of the top 20 funds on Cofunds were multi-manager offerings.
In the face of this apparently unshakeable trend, a number of multi-managers have seen fit to boost their teams. Within the last 12 months, for example, Investec has recruited three people for its multi-asset team while F&C Investments and Premier have also made key hires.
There are, however, some challenges to the continued dominance of managed solutions – perhaps most significantly with regard to costs and the disclosure of those costs. This would appear a more pressing issue for discretionary managers than fund of funds, where cost pressures have long been a fact of life. As a result, fund of fund managers have, in many cases, responded but it is by no means clear the same may be said for the discretionary fund management (DFM) arena.
Either way, the revised Markets in Financial Instruments Directive – known for short as ‘MiFID II’ – will make it compulsory for UK investment firms to disclose to clients the total cost of their investments. This will include the cost of advice, product costs, third-party costs, any transaction costs and indeed pretty much anything else that might weigh on investors’ overall returns.
A recent survey by the lang cat consultancy found DFM charging to be opaque and expensive. The analysis, which was conducted for Skandia, compared the total cost of ownership for clients using one of five similar DFM services across seven different platforms. It found a significant difference in price, with the lowest-priced offerings charging around 0.7% and the highest charging around 1.85%. It led lang cat principal Mark Polson to suggest discretionary fund managers appeared to have escaped the competitive pressures so prevalent in the rest of the industry.
Other recent research, this time from Defaqto, paints a similar picture. It found that, while the average annual service fee for bespoke services (on a minimum portfolio of £500,000) is 0.85%, it could be as low as 0.25% and as high as 1.5%. It also found the more commoditised managed portfolio services have an average annual service charge (on a minimum portfolio of £100,000) of just over 0.7% but operate in a similar range of charges to the bespoke services.
Equally, discretionary managers are facing competitive pressures from new launches. February saw the long-awaited launch from Skandia WealthSelect, which builds portfolios using 55 funds from 10 providers, with an average annual management charge of 0.52%. Whitechurch Securities also recently launched a low-cost range of discretionary funds and discretionary managers will also face competition from passive funds.
Some have risen to this challenge with aplomb – for example, 7IM's active range continues to outperform its passive range and at relatively low cost. At the same time, the group is now experimenting with ‘smart beta’ products to optimise its passive range’s performance. However, this remains more the exception than the rule.
This leads onto another issue facing managed solutions – commoditisation. There has been much talk of a ‘winner takes all’ mentality – the theory being that fund selection is increasingly concentrated in the hands of just a few players. Many have the same selection criteria and many are also focused on larger funds because of the amount of money they have under their control. They require sufficient liquidity to be able to put all clients of a particular risk type in the same fund.
This is the natural consequence of a strict interpretation of the suitability rules, which force fund selectors to buy into, or sell out of, any fund that cannot be used for all clients with the same risk profile. In this way, any claims towards independence of investment choice are somewhat in conflict with current regulation.
There is also a danger that investors get wise to this commoditisation and decide that – all other things being equal – discretionary fund managers offer little over a fund of funds vehicles. Some discretionary managers require investable assets running into millions before offering any sort of bespoke service. Plenty of high net worth clients are unlikely to be comfortable with this.
Multi-managers have more flexibility and many can still asset allocate dexterously although weight of assets can still create problems – one notable incident being when Threadneedle’s Emerging Market Bond fund lost around half its assets after Jupiter’s multi-manager team withdrew its support. More broadly, multi-managers can struggle to move money into and out of retail funds or take meaningful positions in relatively illiquid asset classes.
Problems also persist for discretionary managers at the opposite end of the spectrum. As Tony Bray, head of client relationships at support services firm threesixty, recently observed, advisers may often be unaware their discretionary managers are investing in unregulated collective investment schemes – thus potentially creating a conflict. It seems discretionary managers may be in a lose/lose scenario here, which comes on top of other natural disadvantages compared with fund of funds, such as VAT on fees and potential capital gains tax liabilities.
Of course, fund of funds also have their issues – not least the ongoing debate on the respective merits of risk rating and risk targeting. According to Mike Webb, chief executive of Rathbone Unit Trust Management, for example, the volatility-based, risk-measured funds may be at risk in a rising interest rate environment. “The traditional thinking behind a model portfolio ignores the environment we are in at any one moment,” he explains. “It means a manager may be heavily invested in fixed income because that is what stochastic modelling says.”
The big danger here, of course, is that backward-looking risk ratings categorise bonds as being low-volatility. As a result, supposedly low-volatility funds may be stuffed full of bonds that, in an environment of rising interest rates, would prove far higher-risk than investors are likely to expect.
Yet the majority of the industry appears to have gone with risk rating and a recent survey of advisers by Investec Wealth & Investment found a little over two-thirds (68%) of respondents reporting no difficulty in aligning their firm’s approach to client risk assessment and profiling to selected discretionary fund managers.
Still, it makes for a challenging environment, to say the least, as advisers look to decide on a suitable investment outsourcing partner – and indeed the Investec survey also found more than three-fifths (63%) of respondents supported the introduction of an industry standard covering advice and discretionary fund managers.
Discretionary fund managers are by no means out of the game but neither has it proved the one-way traffic many might have envisaged in the post-RDR environment. One finding of Adviser Hub’s own survey of its 9,000-plus usership, carried out earlier this year, was that where our users were using discretionary fund managers, it was usually through longstanding, trusted partnerships. Nor was it always the bigger, more recognisable names but, instead, those who brought something different to their clients.
Advisers may now have significantly more choice when it comes to investment outsourcing but this makes it even more crucial they ensure they are not settling for mediocrity.