The choice between investing through a discretionary fund manager and a fund-of-funds product is widely debated by investors, who face the difficult decision of which method is better suited to their particular circumstances.
There are large similarities between the two approaches – both invest in a range of funds across different asset classes to build a diversified portfolio and, usually, both offer access across the risk spectrum.
So what are the fundamental differences between investing with a discretionary fund manager (DFM) or a multi-manager, and how do investors know which is right for them?
Flexibility
Neil Jones (pictured), investment manager at Hargreave Hale, says the biggest difference between the two services is the flexibility for the client. 
“We typically manage our clients for a number of years and of course people’s circumstances change over that time. At the beginning of people’s lives they will be saving and starting to earn more, then they may get married and have children so their circumstances change. It might be that they’re saving for a new house, for example, it might be a new car. All the way through, people’s lives are evolving and therefore you want your portfolio to evolve with you,” he said.
“I think that adds a lot of value because it’s something that’s appropriate for the client, rather than putting them into the best fit of the box.”
Tristan Scrivens, owner of independent financial adviser firm Elm Financial Management, uses both multi-managers and discretionaries but says the bespoke service provided by DFMs can be invaluable for certain investors.
“It could be someone who is a divorced housewife, for example, and that is the money they have to survive on or it could be a retired pensioner who doesn’t want to take massive amounts of risk but they don’t want to sit in cash at the same time,” he explained.
“With DFM, you can sit down with the manager and you can discuss these circumstances, so the manager can then get a better understanding of their situation. If you invest in multi-manager funds, you don’t really have that control over it.”
Pressure to perform
However, Simon Evan-Cook, senior investment manager at Premier Multi-Asset Funds, says that not offering a bespoke portfolio in fact gives fund of funds the upper hand, as every investment decision the multi-manager makes affects the unit price going forwards and increases performance pressure.
“Each one of our funds has a single price and it’s therefore very easy to compare that to its peers or benchmark,” he pointed out.
“Obviously [DFMs] have the individual relationship with the client. They know Mr and Mrs Miggins, they talk to them and they ask how their kids are, so there’s an ability, if you like, to effectively charm your way out of it if you do make a mistake.”
“I don’t have that luxury as a fund of funds manager. If I make a mistake then people will sell the fund – I don’t get a chance to talk to clients directly. We’re on more of a knife edge and we absolutely have to be right.”
Evan-Cook adds that investors are likely to get a more diversified portfolio with a wider range of funds from a multi-manager, from off-the-radar investment vehicles to bigger household names, as they don’t carry the burden of essentially selling each fund to a client.
“If I found an interesting UK fund that had been running for six months, for example, and even if in that six months it had performed poorly, I can buy that because there might be a very compelling reason to – for instance it’s great value and the portfolio manager has done extremely well somewhere else,” he reasoned.
“A discretionary fund manager has to explain to their clients face-to-face why they’re buying that fund. It would just be easier for them to say, ‘actually I’m just sticking with this big fund over here run by a well-known fund manager from a fund house that you’ve heard of’.”
“They’ve got less incentive to go off the beaten track, whereas we go off the beaten track quite a lot in the search of the very best fund manager talent because it matters to us what the fund is going to do tomorrow or the day after. It doesn’t really matter what it’s done in the past.”
Convenience of risk ratings
Scrivens agrees that multi-managers’ fund selection process is attractive due to their risk rating.
“I think risk-rated funds are the way forward. I’ve used them a lot, for example, for ISA portfolios which are relatively small and they’ve been brilliant – they’ve performed amazingly well. Even in their dips, if you compare the market to where we were last year and you had gone into a tracker, you’d be pretty much exactly where you were and you wouldn’t have much money at all,” he said.
“However if you use, for instance, the Standard Life Investments MyFolio Managed III fund, you would have seen returns of around 8 per cent. It shows [multi-managers] are being active on it and they are being well-managed.”
Performance of fund vs index over 1yr
Source: FE Analytics
Scrivens admits that when he used to compile his own diversified portfolios, he found it difficult to keep up with the wide range of investment vehicles and constantly altering everyone’s portfolios.
“If you’re using these risk-rated funds, they’ve got their research teams and when they’re ready to change out, they change out. It’s a much better way of doing it and it’s more efficient – it’s a cheaper way of doing it, especially if you’re blending the multi-manager funds,” he explained.
“If you’ve got different risk-rated funds, the annual management charge is usually around 0.9 to 1 per cent, because some are cheaper than others, so you’ve got a cost factor you can save on there by diversifying in the risk-rated funds themselves.”
Cost
Cost is hotly debated when choosing between a DFM and a multi-manager. Some investors think the ongoing charges fees that fund of funds charge are expensive, while other investors are wary of costs stacking up when employing a discretionary fund manager.
“DFMs still get the institutional rates – they still buy in bulk because when they’ve got the risk-rated portfolio they hold a lot of it within each of the client’s portfolios, so if they’re selling something for one client, they’ll sell the lot because their research team has told them that it’s no longer a good asset class or fund to be in,” Scrivens said.
“Clients have asked me, ‘Why DFMs?’, because surely I get worried about their charges. DFMs used to get a commission for each transaction, whereas now that’s not the case. Some DFMs are old-school in that way, but certainly the ones I use don’t. They charge the annual management fee and then that’s it.”
He adds that charges for multi-managers and discretionaries are in fact similar, but choosing which one to use is dependent on the amount of money that is being invested.
“For a multi-manager, you’d generally invest under £100,000 in it, otherwise with DFMs the charges outweigh the benefits in most cases. They usually like to have a minimum sum because otherwise they can’t diversify their portfolio enough either to spread the risk,” he added.
However, Jones believes that multi-managers accumulate various charges, which can add up to hefty costs for the investor.
“By the time you’ve got all the different layers of charges through a funds of funds approach, I think it’s actually cheaper to employ a discretionary manager and receive a bespoke service than it is to take a multi-manager approach,” he said.
Tax benefits
Whereas cost may be somewhat of a grey area, Evan-Cook (pictured) says one outright benefit multi-managers have that isn’t debatable is the tax difference – fund of funds are free from both VAT and capital gains tax (CGT). 
“To give an extreme example, if I wanted to sell all the holdings in our global growth fund tomorrow, I could and I wouldn’t have to worry about what capital gains tax implications that would have for my clients because it’s free of CGT and I can do what I like,” he said.
“I would have to take that into consideration if I were running a discretionary portfolio outside of a fund structure for a client. Therefore I maybe wouldn’t make the best decision and I maybe wouldn’t get the best outcome.”
“That’s fairly set in stone, but actually some DFMs might say that being able to trigger CGT could be quite useful, but I think on the whole if that bit doesn’t cloud my thinking, it helps.”
Use one or both?
While there are positives and negatives to both methods of investing, Scrivens believes the best way to utilise DFMs and multi-managers is to maintain a mixture of both, where possible.
He said: “I tend to split my exposure to each – I wouldn’t put it all with one multi-manager and I wouldn’t necessarily look to put it all with one DFM.”
“The reason for that is spreading the managerial risk as well as everything else. If the manager messes it up then you client doesn’t suffer as much because the other one is likely to, or hopefully, will have done a bit better.”
What are your thoughts? Do you use multi-managers, funds of funds, both or neither? We’d love to hear your comments below.
