The NURS effect on multi-manager funds

In October 1991 they changed the rules on fund of fund unit trusts so that one could buy underlying funds at ‘best’ rather than at creation.  This was a massive change which let the multi-manager genie out of the bottle and, as they say, the rest is history. 

 I was fortunate in being a private client fund manager at the time and had already rearranged most clients’ portfolios into one or more ‘models’ which, in those steam-driven days, we controlled by spreadsheet.  The new rules meant that we could establish a number of new fund of funds unit trusts to replicate our models and conveniently share-exchange most of our clients into them.  This made a huge difference both in our ability to manage actively and to put aside any previous worries about creating CGT liabilities for clients as a result of our active management.

 There was a major drawback, however, as far as I was concerned.  Many of our models (remember this was 1991) had previously included direct Gilt holdings which we bought for individual clients within their portfolios.  This was because it was easier to control individual Gift holdings and their yields than if one bought into what were, in any case, rather expensive Gilt unit trusts.  We had no choice once we had moved to fund of funds because each unit trust was either designated as a securities fund – which could buy individual equities and Gilts – or a fund of funds – which could only buy other funds (including Gilt trusts but not Gilts directly).

 A couple of years ago there was a long overdue and massive change to the regulation of collective funds within the UK with the introduction of UCITS 3 and, in the context of asset allocation, the introduction of NURS (non-UCITS retail schemes).  Many funds launched in the last couple of years have been launched as NURS schemes and several other pre-existing funds have been converted into NURS.  The benefits of NURS within multi-management are absolutely legion, especially as fund management becomes more sophisticated and new and slightly esoteric investment opportunities unfold.

 It is now possible to mix all sorts of asset classes and types within the same fund so that both risk and reward can be enhanced by blending the most contemporary of investment vehicles.  A NURS fund can invest up to 20% in a mix of unapproved securities and unregulated collective investment schemes (including hedge funds).  It can have permanent borrowings of up to 10% permitting a minor level of gearing.  It can comprise larger holdings both of individual securities and of collectives.  Importantly it can invest in property and gold.

 These possibilities open all sorts of doors for the professional manager and as a result many fund of fund managers are choosing to switch their multi-manager portfolios to NURS rules.  This allows them so much more freedom to mix and match investment types and include absolute return funds, structured products, bricks and mortar, funds from strange or specialist jurisdictions as well as commodities. 

 NURS rules permit managers to select funds which are managed very precisely by objective or within very esoteric areas, such as oil exploration or particular commodities.  Funds such as these are frequently closed-ended funds (often investment trusts) which allow their own managers to drive longer term strategies without having to worry about their capital base shrinking or expanding through outflows or inflows of shareholder money.

 A major attraction of closed ended funds is their tendency to fluctuate between discounts and premiums (being under or over valued) depending on market movements.  Often a manager of a multi-manager fund can pick up shares in an investment trust very cheaply where both the sector and thereby the trust are under-valued.  When there is a recovery there is likely to be a double rise enjoyed as both the sector and the fund move northwards.

 Because of the flexibility within NURS and the increased choice and complexity of options available to managers and, particularly, to multi-managers, there is a far greater degree of skill and experience which must be brought to bear.  This is why returns from well run multi-manager portfolios, which have always tended to be superior to single manager funds within each relevant sector, are becoming ever more competitive.

 There has always been a strong case for multi-management in achieving economies of scale, tax-efficiency, wider diversification, lower risk and higher returns, compared with running individual portfolios of shares or collectives.  But the recent emergence of highly sophisticated asset blending with judicious use of derivatives and other contemporary vehicles, following the introduction of NURS rules, means that the performance gap between old style collectives and new style funds is likely to increase even further as time goes by.

 This differentiation has brought multi-manager investing to new levels of sophistication.  Nowhere is this more obvious than within the Cautious Sector where managers can now incorporate absolute return funds, guaranteed funds and property funds into the mix to reduce both volatility and the degree of correlation between cautious funds and the equity markets.  It is time for investors to re-evaluate the quality of NURS funds operating within the Cautious Sector.

 One of the great difficulties is the preoccupation within the market place for looking at performance tables.  Many truly cautious funds, such as WAY’s own, have a benchmark equity weighting of some 30% against an IMA benchmark for the cautious managed sector of “up to 60%”.  This means that these more cautious funds will always under-perform the sector during bull market conditions because they have far less of an allocation to the single asset class which is going like an express train. 

 One has to ask whether a portfolio which contains 60% equities can reasonably be described as cautious.  To my mind we are still operating in sectors based on investment considerations from the last century.  In today’s markets there is much greater sophistication.  When one currently talks of caution we are not talking about focusing on high income equities or simply reducing the equity allocation by a few per cent, we are talking about a well-diversified portfolio containing a range of asset classes including property, absolute and guaranteed funds.  These will deliver lower volatility and robust cautious performance but they will not deliver 60% of equity performance!  Whilst the IMA Cautious Sector is full of equity income funds earning star ratings, the genuinely cautious funds will get little credit for the wonderful job many of them do for their cautious unitholders.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 15th October, 2007 |
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