Funds-of-funds are often recommended as being the ideal option for the core of an investors’ portfolio but research by FE Trustnet shows that their performance lagged that of their multi-asset peers by a wide margin over the past decade. 
Funds of funds, or multi-manager, products build their portfolios from other funds, with their fans arguing that this leads to well-diversified propositions where investment decisions are outsourced to specialists in their fields.
This isn’t the only way to build a diversified portfolio, however, with other multi-asset funds opting to choose their own holdings rather than going through other fund managers. Supporters of this approach note that this often comes at a lower cost than funds-of-funds.
FE Trustnet decided to test both approaches, to see if either has been stronger on average over the past one, three, five and 10 years to the end of September 2019. To do this, we looked at the four main multi-asset sectors in the Investment Association universe: IA Mixed Investment 0-35% Shares, IA Mixed Investment 20-60% Shares, IA Mixed Investment 40-85% Shares and IA Flexible Investment.
Source: FE Analytics
As can be seen from the table above, the average multi-asset fund has outperformed over all four time frames in the IA Mixed Investment 0-35% Shares, IA Mixed Investment 20-60% Shares and IA Mixed Investment 40-85% Shares sectors. The performance difference has been most clear in the last two peer groups, which were formerly known as the cautious and balanced sectors.
Multi-manager funds, however, did beat their multi-asset rivals on average in the IA Flexible Investment sector over three, five and 10 years – although it must be noted that, as its name suggests, there is a wide range of strategies and risk profiles at play in this peer group and comparisons are difficult.
Focusing on the past 10 years, every one of the top-10 performing funds in the IA Mixed Investment 40-85% Shares sector have a multi-asset approach with Royal London Sustainable World Trust (238.55 per cent), Baillie Gifford Managed (171.23 per cent) and MFM Hathaway (159.35 per cent) being at the top of the table.
Premier Multi-Asset Growth & Income is the highest ranked multi-manager fund, appearing in 12th place with its 128.07 per cent total return over the past decade.
In the IA Mixed Investment 20-60% Shares sector, six of the top 10 are multi-asset funds with Royal London Sustainable Diversified Trust (147.44 per cent) and AXA Global Distribution (114.94 per cent) holding the first two spots. A multi-manager fund – Premier Multi-Asset Distribution – comes in the third after making 114.34 per cent.
We also repeated the above exercise using the Sharpe ratio, to show if multi-asset has outperformed multi-manager from a risk-adjusted returns point of view.
Source: FE Analytics
The results are slightly different, but still show strong outperformance by cautious and balanced multi-asset funds over the four time frames we looked at in this research.
We asked David Coombs, head of multi-asset investments at Rathbones, why he thinks a multi-asset approach appears to have beaten funds-of-funds on average.
Coombs runs the Rathbone Strategic Growth Portfolio, Rathbone Total Return Portfolio, Rathbone Enhanced Growth Portfolio and Rathbone Strategic Income Portfolio funds, which used to take a multi-manager approach but changed to choose their own securities around four years ago.
The manager said there were several key reasons why he decided to change his approach following a career of using a fund-of-funds model.
“One was to be able to really invest in line with our own views, rather than outsourcing to others who may take a differing view on a particular theme, issue, risk or whatever,” he explained.
“Transparency was also a reason – if you invest directly then you can see the whole portfolio and you know how it’s reacting on a day-by-day or hour-by-hour basis. You can be much more precise in your risk management by having total control over what you’re buying.
“Of course, the other benefit of doing this is that we stripped out about 100 basis points minimum of annual cost. In a world of low rates and lower returns, the cumulative impact of that per annum is pretty big.”
Performance of Rathbone Strategic Growth Portfolio vs sector over 4yrs
Source: FE Analytics
Another potential issue with multi-manager funds is the risk of overdiversification – owning too many funds in a portfolio can led to lots and lots of underlying holdings.
“If you blend too many funds together you end up back at the index and, because of the fees, this becomes a big headwind. I always thought that you should pick one or two funds and try to stick to a style to implement a view,” Coombs said.
“You could be right or wrong, of course, but if you do the other approach and overdiversify then everything balances out and you end up with market-like returns. If you look at the old textbooks, they say you don’t need more than 45 stocks to have a diversified portfolio; if you’re a multi-manager fund with 50 holdings, then you have thousands upon thousands of underlying stocks.”
Coombs conceded that he cannot categorically say if a multi-asset or multi-manager approach would have worked best for his range over the past few years, as he does not know what the results would have been if he stuck with running funds-of-funds.
However, he noted that the range’s assets under management have climbed from around £200m before the change to about £1.4bn today – which he believes is down to the performance of his multi-asset approach.
“For us it was about having greater flexibility, being able to back conviction and improving risk management. I think we’ve seen all that since we made the move,” he said. “It’s hard to prove, but my gut says that this was the right thing to do.”
“That’s not to say I don’t think multi-manager has a place – I still think it does. Maybe not in the retail market, but in the institutional market that approach can have a use. But I think you have got to have a more focused approach, with fewer funds, keeping them for longer and being more punchy in your calls.
“From my own experience of trying to evolve a multi-manager product over many years and eventually giving up on that approach, if you’re investing in lots of funds and move around then the chances of outperformance are pretty low.”