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Are funds of funds really the “biggest con in this industry”?

15 May 2015

Funds of funds often come under fire from regular FE Trustnet readers, but data from FE Analytics shows they have actually performed well over the longer term.

By Alex Paget,

Senior Reporter, FE Trustnet

It is almost guaranteed that when funds of funds are mentioned in an FE Trustnet article, they are panned by some of our readers.

Over the years, some of have dubbed them as the go-to option for “lazy IFAs” while others have gone a step further with one notable commenter describing funds of funds as the “biggest con in this industry”.

It is understandable why they are so hated by some people, given that fees and costs are among the key factors for most private investors. And, given they are active funds buying other funds, they tend to charge more than traditional straight equity, bond, property or multi-asset rivals.

In fact, it isn’t uncommon to see funds of funds costing investors more than 2 per cent in ongoing charges.

Given that they are already at a disadvantage to their more traditional peers because of this, the common-held view is that they underperform. However, using data from FE Analytics we put this theory to test and the results were quite surprising.

We started in the UK equity sectors, where there are a handful of funds of funds such as HL Multi Manager Income & Growth, Schroder MM Growth and GAM MP UK Equity.

Firstly, it must be pointed out that funds of funds are designed to be ‘one-stop-shops’ and therefore those which reside in the IA UK Equity Income and IA UK All Companies sector only buy funds which sit in those peers groups – so it is unlikely that they will sit right at the top of the performance tables.

However, while an equally weighted portfolio of the four fund of funds in the UK Equity Income sector has narrowly underperformed against the peer group average over five years, its returns of 65.85 per cent are greater than the FTSE All Share’s gains of 59.11 per cent.

Performance of composite portfolio versus sector and index over 5yrs

 

Source: FE Analytics

It is a similar story over one and three years as, while by no-means outstanding, the portfolio has outperformed the wider equity market.

Though UK equity income funds of funds lagged in rising markets like 2010 and 2013, they outperformed both the sector and index in the falling market of 2011 and the turbulent conditions of 2014.

The data is very similar when we looked at the five funds of funds in the IA UK All Companies sector.

Our data shows, up until recent months, they have delivered almost exactly the same returns as the sector average over the last five years. They have also outperformed the FTSE All Share over that time as well.

Performance of composite portfolio versus sector an index over 5yrs

 

Source: FE Analytics


 

Of course, like with any sector, there have been funds of funds which have underperformed.

The stand-out UK fund of funds, though, has undoubtedly been the five crown-rated HL Multi Manager Income & Growth portfolio, which is headed up by Lee Gardhouse and Ellen Powley.

According to FE Analytics, the £1bn fund has been a top-decile performer in the IA UK Equity Income sector since its launch in October 2002 with returns of 255.2 per cent, beating the FTSE All Share by 60 percentage points.

HL Multi Manager Income & Growth has also beaten the index in eight out of the last 10 calendar years, meaning it is outperforming over one, three, five and 10-year periods.

 

 

Source: FE Analytics  

The fund, which has an ongoing charges figure (OCF) of 1.36 per cent and yields 3.7 per cent, counts the likes of CF Woodford Equity Income, JOHCM UK Equity Income and Marlborough Multi Cap Income as top 10 holdings.

Though investors may turn to a fund of funds for equity exposure, it is more common that they are used as a core holding or, in some circumstances, the only holding for investors who don’t have the time, information or ability to manoeuvre their portfolios independently.

Certainly, this is where there one-stop-shop characteristics come into play.

Therefore, we looked at the performance of mixed-asset funds of funds versus funds which have direct exposure to bonds, equities, properties and alternative investments.

While these are the ones which can come under the most criticism, FE data shows an equally weighted portfolio of funds of funds in the IA Mixed Investment 20%-60% Shares sector has narrowly outperformed the average peer over the last five years with returns of 34.95 per cent. They are also outperforming over one and three years.

Performance of composite portfolio versus sector over 5yrs

 

Source: FE Analytics

Some of the best funds of funds performers in the old balanced sector include the likes of the five crown-rated Standard Life Investments Dynamic Distribution, the five crown-rated Premier Multi-Asset Monthly Income fund and the £1.1bn F&C MM Navigator Distribution fund which is headed up by Rob Burdett and Gary Potter.

In the IA Mixed Investment 40%-85% Shares sector, our data shows funds of funds have also narrowly outperformed the sector average over five years with returns of 42.05 per cent.


 

Mike Deverell, investment manager at Equilibrium, says that like with any part of the market, investors need to be selective when it comes to funds of funds. However, he says much of the criticism directed towards them is unfounded.

“I think, essentially, there are really good funds of funds out there and some which aren’t very good,” Deverell (pictured) said.

“People are right because one thing you have to be wary of is cost as, overall, you are paying for two fund manager fees. However, if they are good at it, fund of funds managers should be able to add value and that is shown in your figures.”

“In the multi-asset sectors, if you were to compare fund of funds against non-fund of funds, yes they have higher charges, but on the other hand there are very few managers out there who are experts in UK equities and overseas and other asset classes.”

“Therefore it makes sense to use specialist managers for your exposure. But, it all comes down to how good they are at picking fund managers. I think the Jupiter Merlin team are really good, though they haven’t performed too well recently.”

He added: “I also like 7IM as if you want a low cost option they have active asset allocation strategies which only use passive funds.”

Nevertheless, Deverell does understand the “lazy IFA” argument surrounding funds of funds and says that private investors must make sure they are getting the best possible deal.

“What I would say is that if you are paying your IFA 1 per cent for outsourcing, then paying for the funds of funds manager then the underlying funds they hold, I would question what that 1 per cent is for.”

He added: “You do have to think about total cost because it is one of the biggest drivers of total returns and is one of the few things you can control.”

 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.