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What advisers need to check before investing client money in outsourced solutions

16 October 2018

BMO Global Asset Management’s Gary Potter looks at the world of outsourced funds, including model portfolios and discretionary fund managers.

By Jonathan Jones,

Senior reporter, FE Trustnet

There are many one-stop shop options available to advisers and their clients, be it multi-manager, model portfolio service or a discretionary fund manager (DFM).

The key for anyone looking to invest in a fund-of-funds vehicle is that it offers diversification, according to BMO Global Asset Management’s Gary Potter.

As a structure all outsourced solutions offer diversification, he said, and will also claim to provide asset allocation, security or fund selection and maybe even portfolio construction as well.

There are many different options out there to choose from. Some offer a mixture of equity and bonds while others may add a bit property and even some absolute return or alternatives as well.

However, for those looking to advisers looking to invest their clients’ capital into a structure it is important to know what they do and don’t invest in when looking at slightly murkier waters.

Below, he looked at a number of different areas that he is able to invest in that other structures may not be making full use of.

One key area is fund size, with many offerings typically choosing to invest in larger, more liquid funds that they can employ across multiple strategies.

“[They are] often focusing on funds that are too big and aren’t ever going to close – what I call the funds of yester year,” Potter said.

This is also typically linked to track record, with many outsourced solutions requiring some proof of concept before investing in a fund.

However, this can mean they miss out on returns – especially if some of the best fund managers do indeed close their funds before getting to the size required by some of the larger models.

“One fund that we have sold after owning it for five years has just gone on to five platforms after virtually peeking out at capacity. We are gone. We are onto the next one,” said Potter.

Performance of funds vs sector & benchmark since Merian Dynamic Equity launched

 

Source: FE Analytics

Taking pairs of funds with the same teams from the same companies, an example of this is Merian Investors where the £539m Merian UK Dynamic Equity fund, run by FE Alpha Manager Luke Kerr, has performed extremely well since its launch in 2009.

Compare this with industry veteran Richard Buxton and his £2bn Merian UK Alpha fund, which has also done well, beating the FTSE All Share index and the IA UK All Companies sector average over this time.


Kerr has significantly outperformed, returning 386.05 per cent since inception, beating Buxton by 230.34 percentage points.

“It is the same team, same process, same morning meetings, same stock decisions and the same analysts,” Potter said.

“Yet, the model portfolios will tend to buy Buxton and not Luke Kerr because he is closed now – you can’t get in. But we’re in it. We’ve been in for all this period.”

Another example is Artemis US Extended Alpha – managed by Stephen Moore since its launch in 2014 – which has again been a top performer.

“We were the only investor in his fund. Model portfolios thought ‘ooh new fund I can’t own it’,” Potter said.

This compares with Cormac Weldon “an equally decent guy” according to Potter, who’s Artemis US Select has outperformed the S&P 500 since launch in 2014.

The BMO manager said: “He is a very capable investor has done a good job and outperformed the average but Stephen has done even better.

Performance of funds vs sector and benchmark since launch

 

Source: FE Analytics

In this case, both funds were launched at the same time but Moore incorporates a short book – something that some outsourced portfolio providers will find too complicated to deal with.

“I don’t see any model portfolios with Artemis US Extended Alpha because there is a short book and that is far too complicated,” he said.

Size and timeframe are not the only issues facing advisers and their clients, however, with models also avoiding a number of other areas.

“Is your solution able to invest in funds that are capacity constrained? Are they able to invest in newly-launched funds where often the performance can be quite potent in the first few years? Can they use futures and options? I would argue no – but then I would, wouldn’t I?” Potter said.

“More importantly, does it take on some these ideas such as closed-ended funds or funds with performance fees, which are often shunned because of the cost pressure.”

When it comes to the much-criticised performance fee, the co-head of the BMO GAM multi-manager team said he likes funds that have this as it makes the managers even more accountable for how they perform.

Offshore funds are also often overlooked by models because it is too much hassle to deal into Luxembourg of Belgium.


Another thing, the BMO multi-manager said advisers should be careful of is research and in particular the ratings agencies used by these firms.

“These model portfolio solutions often outsource to ratings agencies and it may surprise you that not all ratings agencies are regulated,” Potter (pictured) said.

“Those that are, are the ones that run models. The people that actually do the ratings aren’t always regulated. Why would you want to outsource to people who are less regulated than you?”

These rating agents with often ignore many of the areas listed above, such as smaller funds or new launches, as they do not fit the right criteria for their searches, meaning they are missing out on potentially good investments.

Another hurdle is the availability on the platforms that these models use. Potter said he spoke to a model portfolio provider recently who was a big fan of a fund that he owned but could not invest in it because it was not on platform.

“Why are they not giving their clients the best execution and the best ideas to a phenomenal fund?” he said.

Perhaps the biggest pushback he gets from advisers, however, is on price, with many of these models having much lower fees than his own multi-manage range.

“You pay for what you get. If you want the ‘pound shop’ then go to the ‘pound shop’. Cheap is cheap sometimes for a reason. We come at a slightly higher price and I think that cost is being overly looked on,” he said.

As such, he said it is about “finding the best people and letting them do their job rather than focusing one aspect and finding it at the cheapest possible way”.

Other than the cost aspect, the limitations outlined above mean that going into the next downturn – whenever that comes – investors will soon find out how much value for money they are really receiving.

“I have to say that with a lot of these solutions they don’t have very specialist different types of funds that do offer quite good downside protection,” Potter noted.

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