Are funds of funds just a layer of charges too many for investors?

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The Independent Online

Fidelity, Britain's biggest fund manager, yesterday entered the fast-growing market for multi-manager funds of funds with two products investing in between 15 and 20 rigorously selected funds from such respected investment houses as Lazard, Newton, Henderson, New Star and Artemis. The Fidelity offerings follow hard on the heels of a range of five new multi-manager funds from Abbey, and a clutch of similar products earlier this year.

Fidelity, Britain's biggest fund manager, yesterday entered the fast-growing market for multi-manager funds of funds with two products investing in between 15 and 20 rigorously selected funds from such respected investment houses as Lazard, Newton, Henderson, New Star and Artemis. The Fidelity offerings follow hard on the heels of a range of five new multi-manager funds from Abbey, and a clutch of similar products earlier this year.

Most investment managers now have a product on the market, or plans in the pipeline. The Investment Management Association figures for the second quarter of this year include 131 multi-manager funds, up from 118 six months previously. Yet, as Philippa Gee at the IFA Torquil Clark says, this expansion of supply has not been driven by fierce consumer demand. "We are likely to see the market reaching the point of over-supply soon, given the limited level of investor interest."

That is partly because multi-manager funds have been relatively low-profile compared with single-manager funds, and partly because they have received distinctly mixed reviews. High costs have been a particular issue, because charges are levied by the multi-manager and by the sub-funds within it. And while stock markets have been rising, they have been viewed as mediocre performers compared with specialist funds.

So why have multi-manager funds of funds become flavour of the month among investment managers? Is all the hype really justified from the investor's point of view? And how should we differentiate among the growing number of these funds?

At the IFA Bates Investment, James Dalby says their proliferation is a consequence of the knocks to investor confidence over the past three years. "To rebuild confidence, fund managers have had to present consumers with robust solutions which will see them through both bull and bear markets," he says. "Also, it's now easier for managers to put together multi-manager funds at a reasonable cost, because the underlying fund managers are much more prepared to agree favourable terms than they were in the bull market."

That means these managers will charge the fund-of-funds manager much less than the public to get into the portfolio.

Those "robust solutions" are all about consistency and diversity, rather than sparkling but volatile performance. "The launch of our multi-manager range is an attempt to give customers a more consistent expectation of growth," Guy Greirson, at Abbey, says. "A single-manager fund may be a good choice when you make the investment, but it won't necessarily maintain performance. By introducing a manager to monitor performances and take steps if a fund slips, we aim to cut down that variability."

Fidelity says investors, having learnt their lesson the hard way, are increasingly interested in risk reduction through a more diversified portfolio. "We think the fund-of-funds concept will grow in popularity in the UK as investors seek greater diversification," Richard Wastcoat, Fidelity's UK managing director, says.

The potential benefits of multi-manager funds extend beyond diversification and consistency. For a start, the choice of funds is in the hands of experts using extensive research and lengthy selection procedures. Those experts may have access to high-performing "boutique" funds or managers who do not normally manage retail funds. Isis Asset Management holds the high-performing Mirabaud GB and Thames River Eastern European - neither available to private investors - in its multi-manager Growth and Balanced funds.

Equally importantly, professional multi-managers keep a close eye on the funds, monitoring the performance of the underlying managers to ensure they meet targets, and taking action if necessary should key managers leave an investment house. Multi-manager funds may also help to save investors money, because the fund switches required from time to time within a conventional portfolio are actually made within the fund instead, by the manager. This can save tax.

As Ken Rayner of Bradford & Bingley's IFA arm says, the monitoring process, crucial in any portfolio, is largely ignored by many private investors, particularly the more conservative, passive ones who make up the bulk of B&B's customer base. "Traditionally," he says, "advisers will set up a portfolio and leave it to run, but many of our customers don't follow market trends or portfolio progress. We think multi-manager funds are great for them as a core holding, because they solve that problem."

Competition seems set to reduce multi-manager fund costs, which will help to boost their popularity. The fact that underlying costs can be trimmed means some providers, including Abbey, New Star, Axa and Skandia, are keeping total expense ratios (TERs, showing all the costs and charges taken out of a fund) below 2 per cent. That is still more than most single-manager funds, which charge 1.6 to 1.8 per cent, but a distinct improvement on the 2.4 to 2.8 per cent of providers such as Credit Suisse and Jupiter. Fidelity has set the pace for competitors by capping its TER at 2 per cent, regardless of the costs.

There is always going to be an extra cost because of the monitoring service provided by the multi-manager, but Mr Dalby says: "When investors are comfortable with the level of charges on a multi-manager fund, they will be seriously impressed by the benefits."

But consumers need to understand these funds are not all the same. First, they come in one of two structures. Some, such as the Skandia range and the new Fidelity funds, are funds of funds, sifting and selecting existing products. Others, such as the new Abbey range, are effectively managers of managers, in that they identify and approach high-performing individual managers and give them a chunk of money to manage according to a specific mandate.

Mr Grierson says the latter arrangement offers two advantages. "Because we provide a bespoke mandate, we have more control over the investment strategy they are following. If they underperform and we want to find another manager, we can simply relieve them of their duties: there are still costs but it's cheaper than having to sell out and buy another fund." Abbey's low TERs, ranging between 1.38 per cent and 1.78 per cent, reflect that.

Second, some have not reduced their costs in line with their rivals'. In an environment where consistent growth of say 10 per cent is to be coveted, an extra percentage point siphoned off in charges makes a significant difference over time.

Although Justin Modray at the IFA BestInvest acknowledges the benefits of diversification through multi-manager funds can make sense for investors with less than £20,000, "their use in larger portfolios is often a cop-out that provides the adviser with an easy life but costs the investor more [because of double charging]".

Third, Ms Gee says: "Some providers of multi-manager solutions have not spent as much time on their fund's internal review process as they have on the marketing of the fund." This issue, she believes, will sort the multi-manager wheat from the chaff.

So watch out for a new crop of funds of funds of funds, to save investors the bother of having to choose from all those funds of funds.

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