Putting the squeeze on costs

Jason Britton, chief investment officer at T. Bailey, explains why outsourcing to a multi-manager is RDR-friendly.

There are strong grounds for believing that after the RDR, investors will be much more cost-conscious. We have already seen criticism in the media of active fund management charges.

Today, it is the fund industry under pressure. Tomorrow, it could be advisers. If their businesses are to survive many advisers will have to  find ways to offset lost trail commission through ongoing fees. And they will be under pressure to keep those fees down.

That means focusing on where they add most value and outsourcing the rest in the most cost-effective and client-friendly way possible, to enable them to deliver good, distinctive service cost-effectively, grow their business and maintain profit margins.

The right strategy

Investment is a natural area to outsource. It is costly to deliver – not just on the fund or investment selection side, but in monitoring portfolios, actively managing them and complying with the additional administration and regulatory burdens.
Fund of funds is one solution – and, I would argue, an excellent one for many advisers and their clients. There will be some who might find that difficult to believe. They will flag up the old adage that funds of funds double charge and claim that they are therefore not RDR-friendly.

I have read many of the FSA’s various discussion papers, consultation papers, feedback statements and policy statements on the RDR and nowhere have I seen that we should expect to have lower quality products. We think that funds of funds are a quality solution that, used appropriately, can deliver strong performance.

It should be made clear that funds of funds and multi-manager are not one and the same: the former is a subset of the latter. Funds of funds can also be split down further between internal (or fettered) funds of funds and external (or unfettered) funds of funds. It is the last of these (external funds of funds) which our research shows is the most strongly performing multi-manager strategy.

Where the funds of funds strategy works best relative to single manager funds over the long term is in the IMA Cautious Managed, Balanced Managed, Active Managed and Global sectors. Here, the combination of active asset allocation and fund selection works to best advantage, and here the average external fund of funds has consistently and comfortably outperformed the average single manager (and the average passive product – not that there are many) over the ten-year period to 31 December 2010. And this is after all charges.

Stripping out trail commission, the typical cost of an actively managed fund of funds might be around 75 basis points more than an actively managed single manager fund. For that, the adviser delivers to their client asset allocation, expert fund selection, diversification and active management. The combination of all of these is what helps deliver the long-term outperformance of the strategy, which based on the last ten years more than covers the extra cost.

Investors also get the potential for capital gains tax (CGT) savings because portfolio changes within a fund of funds wrapper do not trigger CGT events. For some investors, the CGT savings alone could exceed the additional charges.