Wholesale use of passives, diversified growth funds and ‘buy’ lists in the financial advisory world could be short-changing the end investor if not used responsibly, warns BMO Asset Management’s Rob Burdett (pictured). 
The co-head of multi-manager solutions says these are currently the fastest-growing areas of the market yet, despite their popularity, are by no means the panacea.
In the below article, he discusses why investors need to tread carefully before utilising these investment trends in their portfolios.
The tracker boom
Burdett says BMO has a genuinely agnostic view on the active versus passive debate. For instance, the firm’s F&C Lifestyle funds permanently hold both types of vehicle and, at any one time, can hold up to 45 per cent in passives. However, this weighting currently stands at around 25 per cent.
“We are a little concerned about some of the ways [passives] are being used within the advisory world,” he said.
The co-head of multi-manager solutions says trackers are an important part of the investment landscape and can offer a solution for investors who can’t afford to take advice and don’t want to decide individual equity weightings themselves. They are also often cheaper than actively-managed funds, which means they are appealing on a valuation basis.
“However, they are really quite aggressively sold into the advice space where they meet, more often than not, a platform charge, almost certainly an advice fee and possibly some asset allocation charges as well. That’s where it gets a bit trickier,” Burdett explained.
“I don’t think these vehicles get mis-sold, but trackers do tend to be promoted based on historic facts whereas active management – and it is sort of its own fault – is promoted on future promise that it will outperform and markets will go up.”
When looking over the last 20 years, his research shows that returns broadly even out to be similar to their respective indices across most sectors, suggesting that both active and passive vehicles need to be considered.
Performance of index vs sector since start of data
Source: FE Analytics
However, he warns that investors need to be prudent in terms of how they gain access to passives.
“We have often heard the 2 per cent figure mentioned by advisers as what they deem a client can stomach in terms of growth for the round trip of advice, investment, asset allocation, use of the platform and so on,” Burdett said.
“If we work with the 2 per cent number and you suck that out of the MSCI AC World [per annum], you go from a 151 per cent return to 88 per cent – it’s reverse compound interest.”
“This has become lost in translation post-RDR; pre-RDR, as the share class we show you in our fund, all of those costs were transparent in your bottom line investment every time you looked at it.”
“Now, for competition purposes, these have been exploded so the clean share classes do not include the whole round trip. The comparisons in the space you and I occupy are dangerous, potentially. The end investor may not be seeing the whole picture.”
Diversified growth funds
Diversified growth funds have certainly increased in popularity over the last year or so, given bearish investor sentiment caused by heightened geopolitical and macroeconomic risk.
According to data from the Investment Association, the IA Targeted Absolute Return sector (which is home to many of these funds) has seen the biggest net retail sales compared to all other sectors during eight out of 11 months to the end of November 2016 (this is the most recent data available).
However, it has been well-documented that many funds in the sector struggled last year, with the four worst-performing funds in the Investment Association universe residing in this market area.
“The posterchild [for diversified growth funds] would be the Standard Life GARS fund, which is the most successful fund of the last decade in terms of asset-raising,” Burdett said.
While the £26bn behemoth fund has comfortably beaten its Libor GBP 6 Months benchmark over three and five years – the fund’s aim is indeed to outperform over rolling three-year time frames – it has struggled over the last year, having fallen by 1.77 per cent.
Performance of fund vs benchmark over 1yr
Source: FE Analytics
Burdett says the fund has rightly been successful over the longer term but warns that, contrary to some retail investors’ beliefs, diversified growth funds aren’t a sure-fire way to protect capital.
“It’s a very complicated product and, again, these things don’t get mis-sold but maybe they get mis-bought and people don’t understand the volatility, which I think they often do in a conventional multi-manager product,” he reasoned.
“It is now behind the IA Targeted Absolute Return sector over three years and it can become a vicious circle.”
“I think this area is here to stay – it’s especially popular in the institutional world – but like all investment sectors it will face challenges.”
‘Buy’ lists
The co-head of multi-manager solutions says that ‘buy’ lists have significantly increased in popularity over recent months and are now commonplace among platforms and wealth management firms.
While he says many of these lists consist of good funds, he warns that there is a lack of back-testing done by the advisers using them.
“If there’s a defining characteristic of the funds on the ‘buy’ list, it’s generally large, well-known industry stalwarts with long-term track records and good ratings. They’re all generally very good funds and almost certainly quite reliable,” Burdett said.
“But, in our space, the advised world, is that enough? Is the return going to cover the costs of the fees?”
“If you’re a large fund with a long track record, you’re on all the ‘buy’ lists, you’re going to get larger and it’s going to take longer to move.”
“The ‘buy’ list providers should hopefully recognise that and factor it in.”
Burdett says that fund size doesn’t negatively impact all fund managers though, and says star manager Neil Woodford is a prime example of this.
The reason for his strong long-term track record, according to the co-head of multi-manager solutions, is that he is unafraid to deviate from the benchmark and take risk, therefore generating significant levels of alpha.
Performance of manager vs peer group composite since start of data
Source: FE Analytics
“Neil is quite happy to be completely absent from major sectors and major components of the index, so there is always enough risk to get a return, although you may have to wait longer than you’re used to as he gets bigger,” he said.
“That is the opposite of what happens with most funds and we do a lot of analysis on size, tracking error, active share, number of holdings, and that’s before getting onto the qualitative screening and the clear conflict of interest of attracting money and keeping money when you have it, relative to continuing the strength of the track record that got you there in the first place.”
“We learned this lesson early on; when you’re investing you need to make the maths work for you, you need to take enough risk to justify your return. Obviously as a multi-manager we have an extra set of costs, that’s probably more clear to us.”