How to keep your balance amid the fund confusion

With a huge range of funds in the same sector and a gulf between the best and worst, investors need to do their homework, says Joe McGrath
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The Independent Online

Sales of so-called "diversified" managed funds rocketed in May, according to figures out this week, showing a return of investor nervousness.

Cautious and balanced managed funds accounted for a combined total of 42.7 per cent of all net sales through fund supermarket cofunds last month, reigniting concerns from financial experts about the suitability of such investment funds.

The Balanced Managed sector is home to 156 funds investing in bonds, equities, property and other funds and was originally supposed to be more risky than the Active Managed sector but less risky than the Cautious Managed sector.

However, recent market volatility has led some critics to lash out at some of the funds within the sector for holding too many "high octane" assets which perform well when markets are on the up, but slump during a downturn.

Under the Investment Management Association's (IMA) sector definition rules, Balanced Managed funds should have no more than 85 per cent of the portfolio invested in equities, with at least 10 per cent of the fund held in non-UK equities.

The broad IMA definition has cultivated a huge range of funds in the same sector but the composition of each fund varies dramatically and the definition alone will not tell you much about the make-up of each fund. Despite warnings, there is still concern that some investors are not entirely familiar with fund prospectuses despite piling in to what they believe is a relatively safe fund.

Philippa Gee, director of Shropshire-based investment adviser Philippa Gee Wealth Management, is among those warning investors not to choose their funds by sector alone.

"Investors must appreciate that just because a fund is in the sector they want, that does not mean it is appropriate," she says. "They should dig further to find out if the fund is a worthy contender. Simply because a fund in this sector is performing well does not mean that it will over the long term. It may be because it has a high cash allocation at all times and while that suits one particular stock market environment it does not suit all and will not be sustainable."

Gee explains that the Balanced Managed sector represents a real headache, even for financial advisers, because it is difficult to use these funds as part of a properly constructed portfolio.

She says: "The problem is that their allocation between different asset classes can tilt so much that the portfolio will never be properly balanced. It makes more sense to build up specific holdings to all these different areas and manage them individually, rather than be beholden to one fund and one fund manager."

Despite the differing strategies between managers within the sector, the fact still remains that there is a gulf between the best and worst performing funds. While most asset managers are continuing to market these funds as having a "balanced" mandate, investors could find themselves massively out of pocket by opting for a manager who is out of step with current market conditions.

The latest survey from What Investment magazine found that a £1,000 investment in the CF Sackville Balanced Portfolio fund would have lost investors £163 in the 10 years to 31 May 2010, compared to the top performing Miton Special Situations fund which would have turned that same £1,000 into £2,277 – a £1,440 difference.

Similarly, the same two funds would have been £399 apart over three years, illustrating the perils of opting for a manager with the wrong strategy. With the competitiveness of the sector increasing and warnings to investors becoming more frequent, it is perhaps unsurprising that managers are becoming more aware of their own shortcomings and the impact this can have on inflows.

This was the case with another of the worst performers. In February last year, Cazenove radically altered the strategy for its Multi Manager Diversity Balanced fund, which was previously known as the Cazenove Portfolio fund. The fund was managed by Anne West and had a relatively mixed record, but has since been taken over by Marcus Brookes and Robin McDonald.

Under Brookes, the fund has been reassigned with a multi-asset remit, with no direct equities whatsoever (it had previously managed all of UK equity holdings internally). The fund is now looking at hedge fund strategies, commodities and a number of UCITS III fund holdings for some "market neutral" positioning.

Brookes, director of Multi Manager at Cazenove, says the fund now has the freedom to adjust its remit whenever it wants within the IMA definition. He explains: "We can pretty much go anywhere as long as the liquidity matches the fund itself. We have different asset allocation parameters now."

For those that are convinced of the virtues of the Balanced Managed approach, however, there are some great funds in the sector but widespread confusion over the likely direction of equities over the coming months has led to huge variations in portfolio allocations from fund managers.

Max King, manager of the Investec Balanced Managed Fund, is one of a handful of managers that are – some say controversially – gearing up for the start of a bull market.

King says that the early signs are already apparent although the real confidence has not yet manifested itself in market stability. He says: "The green light hasn't flashed yet and there are significant headwinds, like the mid-1970s. We have investment grade corporate bonds and a bit of high yield and emerging market debt.

"At the moment we still have gold exposure as well as equities, so that is somewhat contradictory but we look forward to a time when we can sell our gold exposure, as gold will not last forever and there may well be a blow out in the gold price soon."

The apprehension about the arrival of a bull market is more expressively detailed by Smith & Williamson's Nick Marshall, manager of the S&W Endurance Balanced Fund.

He says his portfolio has been "tilting" towards a move defensive stance of late: "If the US was first in and is to be first out of the recession, it is worth investing in, but, equally, if Europe is a geared play on the recovery, it is also worth having.

"I don't think the eurozone is going to break up but we are not out of the woods yet. We have a presence both in the US and Europe but we are currently happy with the composition of the portfolio."

Cazenove's Brookes is even more sceptical of a recovery anytime soon. He believes that the company's bearish in-house view over the past two and half years was justified and is happy to maintain that view for the time being. "It started with Bear Stearns hedge funds going wrong and then the GDP number came through, he says. "Our view is there is no point getting defensive as patterns happen, that has to happen before.

"You end up doing some unpalatable stuff but we feel the obligation to protect the downside is far greater. The governments saw the recession very late. The banks are still technically insolvent and we still have the European sovereign debt crisis. '

Despite this rather gloomy assessment, Brookes agrees that there are indeed some positive signs on the horizon.

This article is based on research published in the July edition of 'What Investment' magazine

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