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Marketed as an investment one-stop shop, multi-manager funds first came to light in the 1980s but became more prominent as an investment model in the 1990s.
The funds are designed to make an investor’s life easier by bringing together a range of specialist managers into a single fund.
There are two types of multi-manager funds: those that invest in a range of other funds controlled by different asset managers, which are called funds of funds (FoF), and those which appoint external managers with specific expertise to invest separate tranches of the provider's portfolio; these are called manager of managers (MoM) funds.
The aim of these funds is to add an extra layer of diversification either through holding funds that have already gone through a process of diversification themselves, or by segmenting a portfolio and outsourcing its management to individuals who have been identified as having proven experience in a particular area.
Until recently there were very few opportunities for individual investors to invest in manager of managers in the UK. Today there are a small number of true MoM fund offerings available to UK investors, and a large and ever growing number of FoF offerings.
A fund of funds is one whose portfolio is selected from other investment funds, giving investors a double level of diversity in their portfolios.
Just as fund managers for single-manager funds vary their approach to stock selection, managers of these FoF choose the funds for their portfolio in a range of ways, with most using a combination of quantitative and qualitative research.
Researchers will look at the ratings that funds have been awarded by agencies such as S&P and OBSR; they will then delve further into the management and performance of potential portfolio members, and will often meet the managers of the single-manager funds.
Funds of funds either operate with a single asset class, UK Equity for instance, or as a mixed fund, such as a ‘Balanced’ fund which will invest in a range of different asset types.
Mixed asset funds are particularly popular because they offer the investor a well-diversified portfolio, selected by an experienced fund manager, all within a single fund. Once investors have decided on their risk profile (sometimes categorised as Aggressive, Balanced or Cautious) all further fund choices are left to the manager in charge of running the FoF. The manager will then monitor and manage the portfolio on behalf of the investor.
As well as the benefits of diversification and expertises, FoF offer a tax advantage. If an investor holds a portfolio of funds directly they would be left with a potential capital gains tax (CGT) charge every time they moved out of one fund into another. By contrast, when sales are made within the FoF’s portfolio no CGT liability is created. Only when the FoF itself is sold would any relevant CGT charge be incurred.
Unfortunately there are some weaknesses in the FoF system. One of the major criticisms levelled at these funds is the cost. Initial charges are comparable to single-manager fund, but ongoing costs can be a lot higher. The typical total expense ratio (TER), which includes all annual costs, is generally 0.5% to 1.5% higher than single-manager funds.
That said, careful research can reveal a number of funds that have made progress in restraining their charges to levels comparable to those of individual funds.
In addition to the cost, investors should watch out for ‘fettered’ funds. A minority of FoF fall into this category, meaning that they are restricted in their scope of investment and can only include funds from the same management group as the overall fund. Through investment in these funds, individuals would not necessarily have access to the ‘best of the best’.
Conversely, the majority of FoF are 'unfettered' so that the fund manager can invest in the funds of other management groups.
Manager of manager funds operate along the lines of institutional investments such as pension funds, foundations and charities. Rather than investing in funds, MoM funds select different investment managers and give each a mandate to make investment decisions. These are known as 'segregated mandates'.
Each manager is responsible for working to the instructions provided by the MoM. Usually the managers will be responsible for a specific asset class, which ensures that the overall fund draws on the expertise of specialists in each field. The segregated mandates are built specifically for the MoM fund and are, therefore, tailored to their precise requirements.
In addition to selecting the manager responsible for each ‘segregated mandate’, the role of the MoM includes monitoring the overall portfolios at a stock-by-stock, manager-by-manager level. By having a number of specialists, instead of one manager investing the fund’s capital, the assumption underpinning MoM is that diversification and outperformance should be more readily achieved.
One significant benefit to investing in MoM funds is the fact that the multi-manager has direct control over the assets and who is responsible for managing them.
This level of control can be extremely important should it be necessary to change one of the underlying investment managers. In such a case, the contents of the segregated account is simply passed to a different manager, avoiding the costs that would be incurred had the investments needed to be cashed in.
The additional benefit of the multi-manager having direct control is that the transition to a new manager is done quickly and efficiently, a difference, which should ensure minimal disruption to the performance of the segregated mandate and, therefore, overall fund.
Due to the scale of investments, managers are able to negotiate lower charges meaning that MoM funds often have low ongoing charges. However, individuals who want to invest in a MoM scheme will have to place a large initial investment – a barrier to entry for the average private investor.
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