What started as a search to cut costs ended up as an in-depth assessment of whether active managers are providing enough alpha to justify their higher fees for IBOSS co-founder and manager Chris Metcalfe. 
“The starting point was cost but basically it ended up being a very large piece of work to find out who was adding value and who was in some cases probably just benefitting from the fact that their particular style was in fashion,” the manager said.
Launched in February last year, Metcalfe runs IBOSS’s six multi-asset funds, each targeting a particular level of risk.
Each invests in four core asset classes; equities, fixed interest, property and cash, with the asset allocation altering according to their risk mandate.
Overall the funds, which previously exclusively used active managers, invested in around 35-40 holdings, and had clean ongoing charges of between 1.1 and 1.36 per cent.
However, in October last year the firm reached a turning point, according to Metcalfe, who says that lowering fees had been something he was looking to do for some time.
Metcalfe (pictured) said: “This debate has been going forever but basically what we did was listened to everybody – the regulators, the financial media, our clients and then their clients – and we spent a lot of hours trying to drill down the alpha of the managers’ funds we were using and how they’d got to it.
“If for instance we could work out that a manager was outperforming in the UK space because they had a small-cap bias and small-cap was outperforming, that’s fine and that is a skill, but it’s only a skill if they are going to rotate potentially out of small-caps at some point.
“So it’s trying to find the managers who are slightly cap-agnostic or style-agnostic and are looking to add value in all circumstances and that is quite a hard task.
“We did this for each of the funds and all of the sectors and we came to the conclusion that we would become 30 per cent passive.”
As a by-product of this, the fees of the portfolios fell by between 30 and 42 basis points each, however he says this decision had more to do with the alpha generation of certain managers.
Another result of this change is that the number of holdings has fallen, with the fund range now allocating passive exposure to areas where it previously would have owned several active managers.
Currently, the fund’s range is 30 per cent allocated to passive vehicles, but Metcalfe says this is not the upper limit and more what feels right for the current market conditions.
“It’s not a hard and fast limit – we have never been particular big on setting rules because if you bring a rule in you can potentially make counterintuitive decisions just to satisfy your rules,” he said.
“The 30 per cent works for current market conditions but that could change over time for instance in the fixed income space its particularly easy with interest rates being so low across the globe to find passive vehicles that will cover things like short-term corporate bonds.
“One of the funds that we are no longer using for example is the Threadneedle Sterling Short Dated Corporate Bond as when we compared the performance of that to the L&G Short Dated Sterling Corporate Bond Index fund the Threadneedle hadn’t been adding value.”
Performance of funds over 1yr
Source: FE Analytics
As the above shows, the L&G Short Dated Sterling Corporate Bond Index has outperformed the Threadneedle Sterling Short Dated Corporate Bond fund by 74 basis points, while charging 26 basis points less in fees.
“Rates are low and the lower the rates get the harder it is for fund managers to add value. Money markets are the most extreme example of it getting harder to add value when interest rates are basically nailed to the floor,” Metcalfe said.
“But if interest rates go up and things normalise I think there is potential for all the bond managers, especially the strategic bond managers, to add value.
“It could be the passive allocation in the fixed income space actually reduces but we don’t make a rule because we could be sitting with relatively low interest rates over the next decade.”
It’s not just in the fixed income sector where the firm has added passive exposure, with index funds in every asset class the range invests in.
“If you take the global sector for instance we are holding five or six funds and we’re also using the L&G International Index Trust fund which is extremely cost-effective,” Metcalfe said.
He adds that the fund excludes UK exposure giving the portfolios a slightly better control of the asset allocation as Metcalfe always holds a higher allocation to the UK in addition to global equity markets.
“That L&G fund is ex UK and is a 4 per cent allocation but the funds we hold around it are the highest conviction, longest track record managers we can come up with,” Metcalfe said.
Within the portfolios’ global asset allocation, he says Old Mutual’s Ian Heslop is the first manager on the list.
“It comes down to this cost-effective, risk-adjusted idea that your passive needs to be as cheap as humanly possible and your active managers have to be absolutely active,” said Metcalfe.
“He has been our highest allocation. We’re using his Global Equity and the geared fund – the Global Equity Absolute Return fund.
“He’s got roughly 7 per cent of the portfolios and in our world that is very high conviction and we’ve been using him for a lot of years.
“The way that team manages money is very different to anybody else and the track record no matter what way you look at it is outstanding.”
The other manager he is backing is FE Alpha Manager Ben Leyland and his five crown-rated JOHCM Global Opportunities.
Performance of funds over 1yr
Source: FE Analytics
Metcalfe said: “Within the global space again the JO Hambro Global Opps fund is interesting because that’s currently underperforming the passive alternative but he [Leyland] has got a high cash weighting and that’s on valuation concerns.
“And that’s fine for us because we have a high cash weighting on valuation concerns and obviously as an underlying individual manager he can move very quickly as he sees it.
“So that fund is a combination of high quality companies which have relatively high valuations, with those that have struggled but it has this defensive backstop of the higher cash weighting.
“If you look at the way markets have gone this year there has been very little to justify the rises in the markets generally. We are quite happy to have one of our funds underperforming in these conditions.”