Why choose a fund of funds?

Multi-manager funds create a balanced portfolio with lower volatility.

CAPE TOWN – There are now more than 1 000 collective investment schemes in South Africa. That includes 177 South African equity general funds, 71 interest bearing funds, 37 South African real estate funds and 32 global general equity funds.

For an individual investor, the thought of trying to select the right funds from this universe can seem onerous. Particularly for those who don’t have the time or inclination to manage their own investments, selecting asset classes and funds within those classes can seem like a chore.

For someone in that position, one option would be to see a financial adviser who can help them through the decision-making process. A good financial adviser will work through an individual’s needs and risk profile and suggest asset allocations and investments to meet those requirements.

Another option, though, particularly for those who may not have a lot of money to invest and therefore can’t afford to build a diversified portfolio, is to use multi-manager funds. By doing this, an investor outsources the asset allocation and fund selection decisions to the fund-of-funds manager, who is effectively acting as an intermediary for all his or her clients.

“There’s just been such a proliferation of unit trusts that it’s not practically possible for a retail investor to be an expert on all of them,” says Adriaan Pask, the chief investment officer at PSG Wealth. “Unfortunately, what often happens is that the companies that spend the most on marketing and become better known to investors attract retail assets, and that’s not the right way of investing.

“So you need a team of experts to look at the industry,” Pask says. “They can look at attractive alternatives and perform ongoing monitoring to ensure that the funds you select are on track to perform to your liking.”

Diversification

They key philosophy behind the multi-manager approach is diversification. The fund-of-funds manager aims to blend different investments together to create a balanced portfolio that should have lower short-term volatility than with a single manager.

This can be done in a single asset class, such as equities, but is most powerful when done across asset classes. That is because the multi-manager is able first to make an asset selection and then to identify the fund or funds best suited to capturing returns from that sector.

“Historically, the pioneers of multi-management wanted to provide a further level of diversification,” Pask says. “Given the desire to blend portfolios and given the proliferation of unit trusts, a need was created to diversify not just across asset classes, but across managers as well. That’s because we recognised that there are different ways of generating superior long-term returns and those different strategies can behave quite differently over the short term.”

Importantly, multi-management gives an investor the benefit of being exposed to the views and performances of a number of different investment houses. That not only reduces risk but also enhances opportunity.

“Everybody can’t be good at everything,” says Fatima Vawda, the managing director of 27Four Investment Managers. “And we don’t believe that each asset manager has a full suite of expert individuals in every asset class. So a multi-manager approach gives us the advantage to use the best in every asset class. We can choose the cream of the crop.”

Top down and bottom up

The best multi-managers are those who recognise the advantage in combining expertise. Understanding that they can’t be experts in every investment area, they identify those fund managers who are.

For instance, Bruce Stewart, who manages the Stewart Macro Equity FoF, is first and foremost a financial planner. He runs a small but focused operation, and wants to ensure the best market exposure for his clients. The fund-of-funds approach gives him that opportunity.

“We don’t have the resources, the capacity or the know-how to identify where we should be looking on a bottom-up basis,” he says. “So we have to identify those individual fund managers who do have that ability. They can’t do my job, and I can’t do their jobs, but there’s a symbiotic relationship between us.”

Successful multi-managers will generally be those who take a top-down view of the investment world and can identify the best managers, asset, sector or style mix for their clients.

“You want to mix uncorrelated asset classes together,” 27Four’s Vawda says. “And once you’ve done that at the asset allocation level, you can do the same thing at manager level.

“There are lots of ways to diversify within equity, for example, such as style, sector and size bias. And these work differently during different market cycles. For instance momentum-driven strategies work well during an expansionary growth phase, and if at that point you’re sitting with 100% assets in a value manager, you are going to struggle. So you want to create a style mix. You don’t put all of your eggs in one basket.”

Stewart agrees that uncorrelated diversification is necessary and beneficial. And he stresses that this benefit is only seen over the long term.

“It is inappropriate and misleading to place a short-term performance interpretation on what is essentially a long-term transaction,” he says. “Investing is about time in the market.”

Costs

The biggest concern investors have when looking at multi-manager funds is cost. This is because funds-of-funds inevitably create an extra layer of fees. You have to pay fees to the multi-manager as well as to all the underlying fund managers.

But that doesn’t mean that all multi-manager funds are expensive. A number are, but there are some who place a lot of emphasis on keeping costs down by negotiating lower fees with the funds in which they invest. As a result, a number of multi-manager multi-asset funds are actually cheaper than certain single-manager alternatives.

The 27Four Balanced Prescient FoF, for example, comes at a TER (total expense ratio) of just 0.87%. That makes it one of the cheapest multi-asset funds in the market.

What many investors also don’t consider is that there can actually be a cost benefit with multi-manager funds. That is because the fund manager can switch between investments without incurring capital gains tax.

If you were running your own portfolio, every time you re-balanced or sold out of one fund to buy into another, you would incur tax on the capital gain. Multi-manager funds avoid this because the money never actually leaves the portfolio and is therefore protected until the investor withdraws it.

Choosing the right multi-manager fund

There are hundreds of multi-manager funds in South Africa, which tells you that the market is far from uniform. There are many different managers offering a range of different approaches.

Some will first address the question of asset allocation and select the best managers to generate performance from within those sectors. Others will simply identify the best managers within a unit trust category and combine those in a single fund.

It’s important for any investor looking at multi-managers to understand that these differences exist and what they mean for their long-term investment. And in future articles we will look at these styles and dig deeper into how they work.

You can read the full article via Moneyweb here.

Author: Patrick Cairns

23 April 2014