In the air

The popularity of multi-manager products has taken off as opinion shifts in their favour. Regulatory changes have prompted the development of funds that offer access to more and varied asset classes. Will Jackson reports.

Funds of funds are a controversial subject in some corners of the investment community. Advisers have traditionally prided themselves on their ability to construct well-balanced client portfolios from individual funds. Sophisticated investors have also called the added value of multi-manager products into question, pointing to extra layers of charging and higher total expense ratios (TERs).

But funds of funds are changing. According to a report from Lipper, TERs have fallen steadily over the past three years, making multi-manager products more attractive in terms of cost. In addition, a broadening of investment powers, under Ucits III and non-Ucits retail scheme (Nurs) regulations, has encouraged the development of multi-asset funds, designed to act as core holdings in investor portfolios and offering exposure to previously inaccessible asset classes.

The growing shift towards greater acceptance of funds of funds is evident in data from Lipper Feri. In its “UK Fund Market Profile” report, published last month, the firm calculated that multi-manager assets accounted for about 8% of all fund assets at the end of 2007, up from 4% in 2001. Open architecture – or “unfettered” – products in particular are increasingly popular, growing from assets of €6 billion (£4.8 billion) in 2002, to €28 billion in the space of just five years. Sales also remain resilient, despite tougher market conditions.

While equity funds saw outflows of £1.35 billion in the first quarter of 2008, funds of funds attracted £250m. Diana Mackay, the chief executive officer at Lipper Feri, says the figures are indicative of a fundamental change in attitudes. “For all the years I have looked at funds of funds, the sector has generated more noise than it has justified,” says Mackay. “Now though, we are seeing more moves into these funds by IFAs who see them as a way of offering a diversified portfolio. It is tentative still, but the evidence is building in that direction. With the credit crunch biting hard, good asset allocation is the key to successful long-term investing.”

Mackay says the arrival of FundQuest earlier this year was significant.

FundQuest – the multi-manager arm of BNP Paribas – expanded its British presence in April, by acquiring Investment Manager Selection (IMS).

The purchase took FundQuest’s assets under management to €47 billion, and was symbolic of growing international interest in British funds of funds. BNP Paribas is one of the largest players in the €110 billion French multi-manager market. The British sector remains comparatively small, at about €45 billion, according to Lipper Feri.

Domestic firms have also taken significant steps to defend or increase their share of the British market. Activity reached a crescendo towards the end of 2007, as several companies established new fund of funds franchises, triggering a series of high-profile manager moves (see box, page 16). Jonathan Polin, director of Resolution Asset Management (RAM), says that although Maia Capital – the firm’s joint-venture multi-manager boutique – was launched into unfavourable market conditions last October, he expects it to account for an increasing proportion of RAM’s assets.

Polin says advisers are turning towards funds of funds, in part, because of regulatory factors, including the growing emphasis on treating customers fairly and the Retail Distribution Review (RDR) discussion. “My view is that we will see more advisers wanting to use solution-based products, rather than picking individual funds,” says Polin. “The RDR is one part of the jigsaw. But it is not just IFAs who are moving towards solutions – a lot of stockbrokers and discretionary people will start shying away from holding individual equities.”

Bernard Henshall, the head of multi-manager distribution at Scottish Widows Investment Partnership (Swip), says the primary driver behind the shift is resources, as advisers increasingly look to focus their time and energy on core competencies. “At a broad level, outsourcing is becoming accepted as a credible option,” says Henshall. “More advisers are realising that their skills and time can be spent more profitably doing other things. A good proportion are coming to the conclusion that a densely-constructed investment process is not central to their proposition.”

Swip recruited Henshall from Winterthur last November, shortly after establishing its fund of funds business.

The firm poached five members of Cazenove’s multi-manager team in September, 2007, and unveiled two retail funds – Diversity and Select Boutiques – at the start of 2008. Because of the adverse market conditions, Henshall says Diversity, a multi-asset fund, has attracted the bulk of investor interest. The fund looked “very similar” to Cazenove Multi-Manager Diversity at launch, he adds, but the asset allocations of the two portfolios have since diverged.

At a product level, the development of multi-asset portfolios was one of the key trends for funds of funds over the past year. Mainstream firms have embraced the wider investment powers offered by Ucits III and Nurs, providing increased competition for established multi-asset specialists such as Midas Capital and Insight Investment. Premier Asset Management was one of the latest companies to enter the arena.

The firm rebranded its Selector Balanced and Selector Growth funds as Multi-Asset Distribution and Multi- Asset Growth on July 1.

Simon Weldon, Premier’s managing director for sales and marketing, says the changes received unanimous support from investors. “The house view is that funds of funds were something for the late 1990s,” says Weldon. “There are more assets and opportunities available, and the old, pure funds of funds are dated as an investment tool. Multiasset is a core way of running money.

Only a brave investment house would say it wants to remain restricted – it would be difficult to justify why the tool-box is only half full.”

However, Weldon adds that greater flexibility does not necessarily mean a “step change” in the management of the Premier funds. The firm will instead use the powers selectively, primarily to increase exposure to structured products – an area of expertise for Premier. Other asset classes will include funds of hedge funds and property. Simon Evan-Cook, an investment analyst in Premier’s pooled funds team, says about 2% of the Multi-Asset Distribution portfolio is invested in Acencia Debt Strategies, a Dublin-listed fund of hedge funds.

Thames River Capital also entered the multi-asset fund of funds market this summer, with the launch of the Dublin-domiciled Multi-Select portfolio for Rob Burdett and Gary Potter, on June 3. The Ucits III-enabled fund has a model asset allocation of one-third in each of equities, bonds and alternatives. However, as expected, the portfolio has taken an initial underweight position in fixed income, with marginal overweights in equities and alternatives.

According to Thames River, its biggest holdings include funds of hedge funds and BlackRock UK Absolute Alpha.

Skandia Investment Group unveiled its Alternative Investments fund later the same month. The portfolio offered exposure to 10 asset classes and strategies at launch: funds of hedge funds, timber, precious metals, water, infrastructure, commodities, currency, global macroeconomic allocation, equity market neutral and volatility.

Alternative Investments uses activelymanaged funds in all areas apart from timber – where exposure comes from a passive tracker run by Mellon Bank. The portfolio aims to generate absolute returns over rolling 12-month periods.

Polin says Maia has temporarily shelved plans for a multi-asset, multimanager fund, but he expects to revisit the subject in the fourth quarter of 2008.

Schroders, meanwhile, spent a “six figure sum” converting its Cautious Managed, Strategic Balanced and High Alpha multi-manager portfolios from Ucits III to Nurs, according to Robin Stoakley, the firm’s managing director of UK retail. The move allows the portfolios to take bigger stakes in single underlying funds, and to hold positions in unregulated investments.

“It is no longer just about the traditional mix of equities, bonds and cash,” says Stoakley. “I see two things; multiasset will grow and multi-manager will grow. Running multi-asset multi-manager will be important and, within a few years, this style will replace traditional managed funds. I would not be surprised if it becomes one of our biggest-selling areas.” As with the Premier funds, the adoption of wider powers has not led Schroders to make immediate asset allocation changes.

“Andrew Yeadon [head of multi-manager at Schroders] is gradually introducing new types of vehicles,” adds Stoakley. “We were never going to dump half the portfolio overnight.”

With funds investing in an ever-expanding range of exotic asset classes, it is surprising that the average cost of investing in funds of funds has fallen since 2005. According to Lipper’s study of 138 multi-manager portfolios from 24 providers, the average TER for unfettered funds declined from 2.51% to 2.34%, between 2005 and 2008. TERs for fettered funds, meanwhile, rose by three basis points between 2007 and 2008, but the longerterm trend is also downwards.

Lipper says tougher fee negotiations by unfettered portfolios with their underlying managers has driven the shift, with funds achieving average management charge rebates of 38 basis points. The firm also suggested that a greater use of exchange-traded funds (ETFs) would reduce TERs further.

Patrick Armstrong, co-head of Insight Investment’s multi-asset group, says the trend towards lower costs is reflected in the TER of the firm’s Diversified Target Return (DTR) fund, which fell below 2% for the first time at the end of 2007. But, he adds, ETFs are only part of the story.

ETFs account for just 6% of DTR, and Armstrong says increased scale – the fund grew from £50m to £400m over the past two years – and a greater use of direct investments have had a bigger impact. Direct holdings include a 20% allocation to bonds from financial institutions, and Armstrong is using low-cost derivatives, such as a swap on the IPD property index. “We are getting the IPD plus 15% for the next 12 months,” he adds. “Even if I could buy open-ended property funds I would not touch them with a bargepole. Swaps are more efficient.”

But, while Insight is focusing on other investment vehicles, Marlborough Fund Managers took Lipper’s call for the wider use of ETFs to its logical conclusion last month. The firm announced that it had opened four actively-managed, Oeic-structured funds of ETFs – previously run for private clients under the MFM iFunds label – to a wider market. The ETF Commodity, Absolute Return, Global Growth and Global Income funds were listed on Cofunds on July 1 – giving many British investors access to such products for the first time.

Stacey Ash, an investment manager and head of marketing at iFunds, says each portfolio holds about 10 underlying ETFs, from a range of third-party providers. “We are the first people to do this, in this structure,” says Ash.

“ETFs are becoming more widely recognised but IFAs have found them difficult to access – if you are not on the major platforms you are excluded.” But Ash rejects the suggestion that funds of ETFs could ultimately pose a threat to more traditional multi-manager portfolios.

“I doubt we would see the whole of the market go that way,” he adds. The consensus, however, is that cost is declining in importance, for investors and fund of funds managers alike. Meera Patel, a senior analyst at Hargreaves Lansdown, says advisers no longer get “bogged down” by costs, and instead focus on which products are outperforming. Stoakley, Polin and Weldon agree. “TERs are important to investors, but there needs to be a rational approach rather than an irrational obsession to get TERs down irrespective, says Weldon. “When markets are difficult the industry tends to focus on cost too much, and not on value. If you are getting something extra for 75 basis points, who cares?”

So, in product terms, how are fund of funds likely to develop? Polin says the baby-boomer market will drive the creation of more “outcome-orientated” funds offering income, rather than growth, over a 10-15 year time-frame.

Lipper Feri’s Mackay also expects longer-term products to increase in popularity, and points to America as the source of the next big trend. “There has been a big move towards target return funds in the US,” says Mackay. “They operate to a glide-path, by moving the balance from an equity bias to an income bias as they approach maturity.”

Mackay highlights target return products run by Fidelity International, but adds that there are few European players at this stage. She also predicts continued growth for multi-asset products. Lipper Feri forecasts a compound annual growth rate of just under 8% for open-architecture funds as a whole, leading to an asset base of €40 billion by 2012. Fettered funds, meanwhile, are set to grow to about €66 billion. This growth will allow the British market to rival France, but Germany is seeing the strongest growth, adds Mackay.

Away from the traditional British multi-manager sector, the long-awaited development of open-ended funds of hedge funds is still under discussion.

The Financial Services Authority (FSA) published a consultation paper on funds of alternative investment funds (FAIFs) last spring, detailing plans to allow retail investors access to hedge funds under the existing Nurs regime. However, the process has been delayed by tax-related issues. The FSA says it aims to publish draft rules for FAIFs in September.

All change as industry expands
The fund of funds industry resembled musical chairs at times last year, as managers switched firms at a dizzying rate. But, in a variation on the traditional party game, the number of available seats steadily increased, as several new players entered the market. Thames River Capital was the first to make its move, in March, 2007.

In a high-profile appointment, the firm announced the recruitment of Gary Potter and Rob Burdett (pictured, right) from Credit Suisse, as co-heads of its multi-manager business. Other members of the Credit Suisse team – Kelly Prior, Paul Green and Anthony Willis – soon decided to follow the pair, as Thames River sought to bolster its newly-established franchise.

Credit Suisse responded swiftly, moving Graham Duce (pictured, left) and Rob Bowie from its private banking division to run the retail multi-manager range. The firm also appointed Aidan Kearney from Premier Asset Management, in April. Kearney, who spent just six months at Premier, joined Duce as co-head of multi-manager. The move reunited Kearney with several funds he previously ran for Artemis, before they were sold to Credit Suisse in 2005.

However, the multi-manager merry-go-round did not begin to gather speed until July, when Resolution Asset Management (RAM) entered the fray. The firm expanded its joint-venture model by setting up a multi-manager boutique with Chris Ralph (pictured, right), Jason Collins and Simon Mungall, all former fund managers at Fidelity International. RAM later named the boutique “Maia Capital”, and unveiled an initial line-up of three onshore and two Dublindomiciled qualified investor funds.

Back at Thames River, Potter and Burdett finally arrived at the firm last August, after a prolonged spell of gardening leave, and announced plans for a range of five core multimanager portfolios. September saw Scottish Widows Investment Partnership (Swip) join the race for fund of funds supremacy. Following the tactics previously employed by Thames River and Resolution, the firm poached a ready-made multi-manager team – this time from Cazenove. Mark Harries took the role of head of multimanager at Swip, with Simon Wood, Lyndon Gill, Natalie Burnard and Andrew Perham in support, as investment directors. Swip also revealed its intentions to launch an initial range of two funds of funds.

Cazenove, meanwhile, recruited Gartmore’s Marcus Brookes (pictured, above left) and Robin McDonald, prompting Gartmore to hire Tony Lanning and Katie Trowsdale from Arbuthnot Latham and Kleinwort Benson respectively.

LV= Asset Management then announced plans to develop a fund of funds capability in October, by recruiting Tom Caddick from F&C. Caddick, who worked alongside Richard Philbin (pictured, above right) under his former employer, was charged with developing a range of multi-manager funds for use throughout the LV= group of companies. In the wake of Caddick’s departure, F&C appointed Dean Cheeseman (pictured, left) as director of its multimanager business, from Forsyth Partners. But just as F&C was focusing on re-building its fund of funds team, the firm was hit by the departure of Philbin earlier this year. Philbin announced his intention to join Architas – a new multi-manager firm supported by Axa – as chief investment officer (CIO). Architas has since taken control of Axa Framlington’s multi-manager portfolios, and appointed Caspar Rock (pictured, right) as its deputy CIO.

Gartmore also lost its head of multi-manager in 2008, as Bambos Hambi stepped down following a strategic review. Lanning and Cheeseman were promoted to head up the fund of funds teams at Gartmore and F&C respectively.