With more and more model portfolios appearing on the market, gbi2 managing director Graham Bentley analyses whether they deliver a better outcome for investors than a simple risk-targeted fund of funds.
For decades, asset managers have been marketing 'funds of funds' (FoFs) as a simple way for investors to access hundreds of underlying securities across global stockmarkets.
FoFs can be divided into two cohorts: those that can choose to invest in competitors' funds are considered 'unfettered', while the rest have chosen to select mainly from their own in-house fund range.
While, given their wider opportunity set, unfettered funds might be expected to exhibit better performance than their fettered cousins, to an extent this is offset by costs.
Unfettered funds have to buy competitors' funds at the going rate and this 'double charge' is reflected in their ongoing charge figures (OCFs), which for actively managed propositions are generally higher than their fettered counterparts.
In contrast, fettered funds buy their own funds on a heavily discounted basis and/or with a significantly reduced annual management charge.
Unfettered FoFs are easier to market than fettered, given the received wisdom that being able to choose fund constituents from the whole market should produce better returns than a restricted product.
That said, there is little evidence unfettered funds outperform their fettered equivalents - costs seem to outweigh the advantages of a wider fund selection pool.
Portfolio management is not confined to a fund structure, of course. Historically, stockbrokers and other investment specialists have used their asset allocation and fund selection skills to combine single-strategy funds and build bespoke discretionary portfolios for individual wealthy clients, although typically with insufficient assets to warrant the associated costs of creating a single-client fund structure.
Over time, the discretionary managers (DFMs) were able to vary their services to the extent the assets of homogenous banks of less wealthy clients could be pooled into portfolio 'models' designed to achieve a shared outcome - growth or income, say - or be subdivided into subjective risk descriptions such as 'cautious', 'balanced', 'adventurous' and so on.
While the DFM's bespoke portfolio involved an intimate relationship with the client, wider portfolio management services based on a model template reflected the manager's relationship with the fund.
Indeed, the manager need not have a relationship with the investor at all - in effect similar to a FoF, but without the tax wrapper.
Financial planners have attempted to access an investment management revenue stream for many years by fulfilling a role as 'fund-pickers' but have eschewed the steps required to offer full discretionary services.
More demanding regulatory, qualification and capital adequacy requirements were barriers to all but the most committed aspiring investment manager.