Over the past couple of years, financial adviser resources have been squeezed to the extent that a number have decided to look to outsourcing solutions for investments for some clients. There are two main reasons for this trend.
One is that, post-RDR, new research and compliance requirements have increased and at the same time product providers have come up with an increasing number of products, often more complex solutions.
Add to this the increased cost needed in terms of governance and regulatory compliance, and it can be cheap and arguably safer to outsource the investment function to a third-party specialist.
When advisory firms consider outsourcing their investment propositions, they can look at a number of options, such as multi-asset funds and discretionary solutions, and even multi-asset funds with a discretionary service attached to it.
In some cases they are seeking a ‘centralised’, or standardised, solution for lower-value clients to manage risk cost-effectively; in others a more bespoke solution is being sought that caters to the needs of higher-net worth customers.
The main reason for choosing a multi-asset over a discretionary solution is that multi-asset funds usually require much lower minimum investment sizes, often £1,000 or less, and fees are generally better expressed.
Beyond this, there can be other, more subtle differences between the two, so much so the lines between the two could be said to be blurring.
If an adviser decides to ‘outsource’ to a multi-asset fund they need to be confident that it does what it says on the tin
A flexible solution
The idea behind investing in a collective is that investor monies are pooled together and everyone benefits from the same investment portfolio. This very simple notion is at the heart of making sure that each client segment has basically the same portfolio and that investment decisions are applied consistently and at the same time.
Pooled monies often give investors access to solutions that require larger minimum commitments than an individual of the investor group would have been able to afford – and the manager of the pool typically has more power to negotiate costs and fees, which are then shared out among the investors.
Multi-asset funds give advisers an outsourcing solution that can be deployed across a variety of client segments, with multiple charging points, enabling ring-fencing of assets and providing access to a compensation scheme.
Of course, if an adviser decides to ‘outsource’ to a multi-asset fund they need to be confident that it does what it says on the tin. In other words, adviser cannot choose a fund for its name or managers’ reputation alone, they need to do detailed due diligence and see whether the fund has delivered on its promise.
Empirically, this means delivering on the stated investment mandate. Consideration should be given to the cost structure as charges can be higher with multi-asset funds. Picking multi-manager funds, which adds a best-of-breed sub-advisory element to the proposition, also comes with an extra layer of charges.
Historically, differentiation between funds was difficult. Charges were the same, areas of investment focus and style were similar; performance or return invariably became the main filter.
Nowadays, as client desired outcome, attitude to risk and capacity for loss can vary significantly, providers have come up with a wide range of funds to help advisers provide suitable solutions for their various client segments. This has left advisers with the huge task to pick solutions for their clients from a complex universe.
This infographic gives advisers a starting point in their research process. It defines the landscape and helps you map out a way to client solutions. To further help, Defaqto and other research agencies provide ratings services, which group together criteria we believe are important for the particular grouping.
We segment funds in many different ways, including whether they are return-focused or risk-targeted, multi-manager or direct (single-manager). A direct fund is where one fund manager or team manages all the investments in the fund, while with multi-manager funds different fund managers are used for different asset classes.
Funds are further categorised into predominantly active or passive, based around the Investment Association sector they’re part of in the case of return-focused, and by asset class in the case of passive funds. Passive funds include both traditional funds (Oeics/UTs) and the more recent exchange-traded funds or ETFs.
We believe that this level of granularity in the research process is necessary to build up a complete picture and compare like with like.
What the infographic visualises is that multi-asset funds come in various shapes and sizes. With over 500 UK-authorised funds available, comprising nearly 2,000 share classes, the landscape certainly offers plenty of choice.
To give this more context, the Investment Association recently announced their post-RDR methodology for nominating primary share classes. Where multiple share classes of a fund exist, the intention is to take the unbundled share class that has the highest charge but that’s free of any rebates or intermediary commission. The share class must also be freely available through retail third-party distributors.
At the end of 2012 many RDR share classes were launched, which makes it impossible to compare performance prior to the launch date unless synthetic performance history is added. The Investment Association has said that post-RDR share classes are to take the track record of pre-RDR bundled retail share classes.
The orange parts in the infographic show the areas we at Defaqto currently rate as part of our independent Star and Diamond Ratings. Given what we’ve just said about outsourcing, it probably won’t surprise you that it’s the multi-asset (and discretionary) areas we cover at the moment rather than single-asset and specialist.
Within the multi-asset space, we’ve identified two different styles: risk-targeted and return-focused.
Risk-targeted funds operate within strict risk bands, typically ranges of volatility, while return-focused funds aim to achieve outperformance, either absolute or relative to a peer group or benchmark – and typically with some risk control. Risk-targeted funds exist as families, with the same team and process behind each fund in the family.
Some of the individual funds within return-focused can also be viewed together as risk-focused families. These families are defined by having a similar management team and process, in some cases even the same team and process. They are set up to follow indirect rather than direct risk targets.
Some of the risk-targeted and risk-focused fund ranges are also unitised discretionary fund families – unitised discretionary fund management or unitised DFM.
Discretionary fund management or DFM (with the exception of unitised DFM) tends to be delivered to the client in two forms.
Firstly, there is the client-specific solution (usually known as bespoke DFM) which can provide a more individual service and investment approach designed for the individual client. This service also tends to focus more on the service aspects, for example including more detailed, perhaps on a face-to-face basis with an investment manager. Charges and minimum investments tend to be significantly higher.
Perhaps more familiar to the adviser is the second type of DFM, known as managed portfolio services. In this case, discretionary managers construct a series of portfolios that they believe will appeal to significant client segments and manage the portfolios according to their own mandates. It is up to the adviser to recommend the more suitable portfolio for the clients’ needs and risk appetite.
Similar to fund structures, all clients in a managed portfolio service solution will have the same portfolio. It is an off-the-shelf solution, so in theory, charges should be lower than for bespoke portfolios. Minimum investments could be as low as £20,000.
Advisers need to keep costs to the client in mind, though. These managed portfolio services portfolios are segregated, which means transactions are subject to potential capital gains tax, and the majority of portfolios are made up of collective investment schemes, so there could be additional charges.
To provide advisers with more resources to help them stay on top of the multi-asset universe, Defaqto has teamed up with the Institute of Financial Planning (IFP). The first document we have produced together, the multi-asset funds factsheet, can now be downloaded here. Rather than being an academic discussion of the universe, these factsheets provide advisers with a practical guide to each type of solution.
Maintaining an up-to-date list of suitable funds
Once suitable funds have been selected, the job is far from done for the adviser. They need to ensure that the solutions they originally selected remain roughly the same over time; the proposition needs to continue to match the original client mandate. If any of the solutions change and the adviser needs to make adjustments, they should already have other solutions ready and researched so that they can offer them in the original solutions’ place.
It’s also important to remember that it’s not just the solutions that can change. Client requirements can evolve as clients get older, their circumstances change or they may have a different attitude to risk or capacity for loss. Advisers should check on an ongoing basis whether changes on the client side need to be reflected in the investment portfolio.