The cult of the star fund manager is over

As the dust settles on the Retail Distribution Review, Advisers continue to fine tune their Investment propositions, with a likely outcome being that they adopt Discretionary Managed Portfolios (DMPs) as an integral part of their proposition.

Research recently commisions by CAERUS Capital group, confirmed something that may had believed for a long while. The cult of the star fund manager is over. Most Advisers have already embraced this and the research also confirms that only a small minority (6%) of clients expect Advisers to chase 'star' fund managers1, who, by their nature, need to continue to take additional risk in the chase for alpha. This is often achieved-or attempted- by taking tactical asset allocation decisions. Take, for example, a fund manager whose fund sites within the IMA mixed investments 40% - 85% sector; that manager is able to change the quity component of the asset allocation to as low as 40% or as high as 85%, depending on his/her outlook. The danger with this approach is that a client, who was matched to an asset allocation by virtue of their risk profile, could find, within a few months, as a result of the manager's decisions, that their investment and their attitude to risk are mis-aligned.

As the identification and classification of clients' risk profiles have developed, Advisers have moved away from single fund solutions and adopted their own model portfolios. Not only do these offer additional diversification and spread ,they allow costs to be reduced by holding a mixture of tracker and active funds to achieve the desired asset allocation.

As the portfolio's starting position changes due to out-performance of one or more of the constituent parts, they are rebalanced back to the starting position. This may sound like an ideal solution; however there are an number of problems with model portfolios which will ultimately drive more advisers towards the use of DMPs.

A number of events can require an Adviser to make changes to their model portfolio(s).

  1. Out performance by one or more funds resulting in 'portfolio drift'.
  2. Fund events - i.e. closures and mergers.
  3. Underperformance from a manager, resluting in the need to switch to a new fund.
  4. A need to realign the portfolio to the original asset allocation, as tactical decisions taken by underlying fund managers have resulted in a significant change in the original set allocation.

While the first of these can be achieved by a simple rebalance, the next three generally require a fund switch. Although fund events may be relatively infrequent, research suggests that the majority of clients2 want their portfolio to be re-balanced continuously to match their risk profile.

With only a minority of Advisers have the required permissions to perform a discretionary switch, the remainder of Advisers who need to make a change to a model portfolio require the written agreement of each and every client in the portfolio. In the post RDR world, this is going to become more of a regular event due to client demand, and therein lies the problem. With every switch requiring client agreement, there will be a small but significant proportion of clients who, for one reason or another, fail to respond in time. the only option will be to create a new version of each portfolio and manage both. So what starts out as maybe five portfolios, can soon grow exponentially, becoming 10,20, then 40 as clients fail to respond to each raft of changes. This, of course adds to the complexity and cost of running Adviser businesses, both in terms of managing a myriad of portfolios and in continuing to communicate with clients in different versions of the the portfolio.

Traditionally, a discretionary fund manager (DFM) would have built a bespoke portfolio for lients. Typically this would have been with the preserve of high net worth clients, those with upwards of £250,000 to invest. However, they could hold the solution to Adviser propositions, going forward. By putting in place a DFM agreement at outset, and allowing the DFM to manage portfolios, am Adviser can side step the need to contact clients whenever a fund switch is required.

Research suggests there is still a demand amongst the vast majority (78%) of investors3, for a portfolio tailored to their personal requirements, as opposed to a 'one size fits all' approach. Part of this will, of course, be matching their attitude to risk to the correct portfolio, but investory may also have a preference for an active or passive investment style and sensitivity to price4.

A solution to this is to use a DFM to manage an active and passive portfolio for each risk profile. The Adviser can then blend these to meet the client's preferences. By leaving the work behind the scenes to the DFM the Adviser can streamline the investment offering and reduce the risks that are inherent in running multiple portfolios, freeing up additional time to advise clients. As advisers start to look in more detail at their investment propositions it is likely that a solution which involves DFMs will become an increasing part of adviser business modles, going forward.

Notes:
Research commissioned by CAERUS Capital Group: Sample size 100(November 2012)

  1. Of all investors, only 6% thought that they should be chasing 'star managers'.
  2. Of those investors who have portfolios, 60% believed that it should be re-balanced continuously to match their risk profile
  3. Of investors who wanted professional management of their portfolio, 78% speceifically wanted a portfolio tailored to their personal requirements
  4. Table showing how much an investor is willing to pay for the management of pensions and investment by an investment professional, on an annual basis, expressed as a percentage of the overall value of the investment.