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Bigger is seldom better: Why the funds industry needs to change

22 February 2015

FE Trustnet’s Josh Ausden highlights a key issue facing financial advisers – the problem of funds getting too big.

By Joshua Ausden,

Head of FE Trustnet Content

It is one of the great paradoxes in fund management that success often leads to disappointment. Top-performing managers understandably get a lot of attention from investors and advisers, and inflows duly follow – especially if the fund in question has a strong marketing effort behind it.

Unfortunately, every fund has a capacity limit, or at least it should. The bigger the sum of money under management, the harder it is for managers to get access to less liquid areas of the market. If, for example, a manager excels at picking sub-£100m companies but runs in excess of £3bn, they would most likely have to be a major shareholder if they want to own a meaningful stake in their fund. This can lead to big problems with liquidity.

There are two possible outcomes of this: either a manager’s ability to add value is badly hampered or the fund is closed to new money to preserve the interests of existing investors.

The second of these is preferable, but unfortunately not as common as it should be. According to a recent poll carried out by FE, 97 per cent of advisers think there is a problem in the industry with regards to funds getting too big. Twenty-eight per cent of those polled said they viewed it as a significant issue.

I for one agree with the 28 per cent. On too many occasions funds have stayed open for longer than they should, and the result is never positive.

I’m keen to stress that I’m not a hater of large funds, and indeed many have proven that their styles and objectives can handle many billions of pounds. Invesco Perpetual Income and High Income are a case in point; these funds have continued to add value not only in the wake of mass inflows but more recently also mass outflows. Funds with less of a focus on mega caps and a higher turnover are less suited to running £20bn-plus, however. 

Schroders and Andy Brough have been big enough to admit that the Schroder UK Mid 250 fund got too big in the aftermath of the financial crisis for example, and Rathbone Income’s Carl Stick admits that the rate of inflows in 2007 and 2008 made life very difficult. Lessons have clearly been learnt in these cases, but there is a risk others will fall into a similar trap.

There are currently question marks over the likes of M&G Recovery, Newton Asian Income and AXA Framlington UK Select Opportunities to name but a few. Double-digit losses and significant outflows for Schroder UK Dynamic Smaller Companies in 2014 has also raised some eyebrows, not helped by the fact it’s now re-opened to new money.

One of my biggest bugbears is how open some firms are about fund size hampering their flexibility. I’ve heard one high profile manager with a long track record of adding value through small and mid-cap companies admit that he can’t hold as much in this area anymore. I’ve heard another say that he’s unlikely to add as much value via stock picking due to assets under management. Neither fund has closed to new money.

A new investor is more likely to accept these limitations, but what about existing investors? Realistically, how many of them are made aware of the changes to the process?

I’m not suggesting that these funds have definitely gotten too big. Mass inflows and worsening performance can often be a coincidence. However, the sheer number of coincidences doesn’t sit well with me. There’s an issue here that needs to be addressed.

What I want to see from fund groups is greater transparency – not after the issue has come to ahead, but before. I’m not expecting managers to say that they will definitely close a fund when it reaches a set figure, as circumstances can change. If, for example, a small cap manager said his fund had a capacity of £500m five years ago but that the market has doubled since then, it’s reasonable to suggest that he could run a greater amount of money today.

That said, some guidance wouldn’t go amiss. The likes of Miton, Majedie and Prusik have been very open with investors about this issue even at launch, giving an estimated figure in most cases. The £377 Miton UK Multi Cap Income fund and £564m Prusik Asian Equity Income fund are much smaller than many of their peers but have closed to new money nonetheless, for example.

More groups need to follow in their footsteps, so that clients can at least ask the question when a set milestone is breached. At the moment there is too much talking around the subject and not enough hard facts – until that changes, this problem will not go away.  

This article originally appeared in Professional Adviser

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