Still strong reasons to run adviser funds

New guidelines on distributor influenced funds are designed to ensure customers are treated fairly and should not prevent advisers from offering their own portfolio-style collective funds.

Access to financial advisers’ own portfolio-style funds can bring benefits for clients. I outlined these benefits in a previous article, which struck a chord with a number of discretionary investment managers, some of whom already run such funds and many who do not but would like to.

Several firms have expressed concerns about the cost, inconvenience and responsibilities of taking this path, as well as the imminent impact of the retail distribution review (RDR) and the alleged negative attitude of the Financial Services Authority (FSA) towards ‘distributor influenced funds’ (DIFs).

Having been involved with DIFs since 1991, I am an avid fan of delivering discretionary investment management to clients via the most effective means: collective investment. What I mean here is delivering sound, bespoke, portfolio-style management via the most cost-effective and tax-effective route by pooling clients’ assets into collective funds.

One size does not fit all, so you will have to supplement this approach by:
(i) having more than one single strategy (fund) to suit different risk appetites and possibly capital and income objectives;
(ii) being prepared to supplement such core solutions with more specialised investments to finely tune each client’s individual portfolio solution.

Two advantages of adviser funds
There are two key arguments for clients entrusting their investment funds to their advisers’ own portfolio-style funds. First, there is far more accountability: the client can meet face-to-face with a good local and personal investment team for regular reassurance about the style and substance of the management.

Second, a good portfolio manager is not the same as a good fund manager. A portfolio manager is running portfolio substitutes and therefore has a keener eye on the overall risk aspects of managing the client’s money. A specialist fund manager works to tight specifications of where they can invest and to what extent they need to maintain liquidity.

The most recent regulatory changes have allowed collective funds to mix and match underlying funds and direct equity investment, and to blend a much wider range of asset classes. This means contemporary portfolio-style funds can effectively mirror and replace virtually any bespoke portfolio.

The right firm for the job
Several firms service the third party fund market. Some are investment management firms, which tend to have more empathy with their guest managers, and others are administration companies, which focus on large scale administration activities. Either type of firm is likely to be able to guide new entrants through the steps needed to establish their own funds.

Whether a firm should embark on this is broadly down to a handful of criteria:

* Are they authorised to perform discretionary management or do they have an associate company who is?

* Do they have sufficient clients and assets under management to make the establishment of such funds a viable proposition for all parties, especially the clients themselves?

* Is there adequate understanding of the regulatory issues involved in running such funds?

* Are such funds likely to survive the commission-free/remuneration policies expected from the final guidelines to come out of the RDR?

* Do the funds comply with FSA guidelines on DIFs?

Support network is growing
A new trade association for companies associated with running their own portfolio-style funds, the Investment Funds Association, is a source of contact and support for its members and a centre of influence with the regulator. The nascent body (ifassociation.co.uk) has a growing membership that includes service providers, and many advisers who run their own branded portfolio-style funds. It may well become an essential forum for parties interested in this sector of the funds industry.

The target of regulations
The FSA has made it clear that its new guidelines on DIFs are not aimed at fund managers, collective scheme operators or private client investment managers whose investment management is central to their business proposition. These groups are already well regulated. They may be affected by the guidelines on DIFs, however, if their appointment as manager or their ongoing investment approach or accountability is under the control of the distributor of the funds in question.

The guidelines focus on several areas of responsibility that together ensure advisers are treating their customers fairly. In essence an adviser must be demonstrably competent, will be aware of, and will manage, any conflicts of interest, is obliged to be independent and deliver only suitable solutions, and must communicate all of these considerations to the client. Included in these issues will be those relating to costs and remuneration.

If this sounds off-putting then take heart: what is genuinely in the best interests of clients will undoubtedly pass muster with the FSA.

Nothing to fear
Regulation on DIFs is there to assist and protect clients and not to deny them the most effective and contemporary investment management solutions.

The regulator has an unenviable task of weeding out the incompetent, unethical or lazy among us. The competent, professional, ethical and conscientious adviser has nothing to fear.

The establishment of well-managed, portfolio-style collective funds will be a major benefit to all participants, advisers as well as clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 10th December, 2009 |
Comments: One Comment

When is a fund a portfolio?

Advisers’ own label funds are highly tax efficient
Clients who invest into IFA firms’ own-label portfolio-style collective funds can gain freedom from capital gains tax on their returns as well as keener pricing and the ability to mix and match funds.

When is a fund a portfolio?
Peter and Mary Singer are recently retired and have been taking advice on how to invest their surplus savings which, of course, includes tax-free lump sums from both Peter’s and Mary’s pensions.

Their adviser works within a major IFA firm which has its own fund management company offering discretionary investment management to clients such as the Singers. They have been advised to place a large part of their available funds within the firm’s own portfolio style collective funds with a smaller proportion directly invested in specialist funds and shares. They are concerned as to whether they are being shepherded into a fund which is as much for the benefit of the adviser as it would be for them.

This is an interesting dilemma which in some ways is part of the focus for the FSA’s current work on the much heralded Retail Distribution Review (RDR) and their recent thoughts on the merits or otherwise of ‘Distributor Influenced Funds’ (DIFs).

The answer lies in provenance
Following the 1980s scandals surrounding broker bond funds it would be lazy to simply write off ‘own label funds’ as yet another self-interested money-making idea for adviser firms. In fact in almost all cases this would be an incorrect assumption. To put these portfolio-style funds into context we need to follow their provenance from the discretionary investment services which have existed for more than a century, to their current highly contemporary manifestation.

It was traditionally the stockbroker to whom investors turned and the stockbroking community has a long history of managing individual bespoke portfolios for wealthy investors. The benefit of bespoke services was that each investor’s own requirements could be satisfied, by an individually-tailored selection of investments making up a personal portfolio. Furthermore the client was in direct personal contact with their stockbroker and was able to derive confidence from the personal nature of the relationship. Going back one hundred years or more the whole industry worked in a more leisurely and controlled manner than hitherto, commensurate with the limited speed of communications and administration of the day. In spite of increasingly volatile markets throughout the 1920s and 1930s, the manner in which these services operated continued undisturbed.

Sea change in control
It was only in the 1980s that a major sea change occurred following Margaret Thatcher’s removal of exchange controls in 1979. Investment managers then had increasing access to the international markets in order to buy shares in successful companies from across the world at the forefront of the new age of globalisation. This coincided with the information age when computerisation and global media access changed the investment scene forever. From that point on it became extremely difficult to operate effectively as a private client stockbroker whilst holding oneself out as an investment manager. Each of those jobs became so specialised that it was impossible to do both well. Either you were a client-facing stockbroker or you were a specialist investment manager. This demarcation has fed through to the typical high net worth advisory firms of today, whether stockbrokers or financial advisers, and the person you see for advice is generally the GP who within the practice employs investment specialists to actually manage client portfolios.

Own-brand portfolio evolution
All very interesting, but the relevance of ‘own brand’ portfolio-style funds is a direct consequence of this evolution and the various factors behind it. I remember managing over 700 individual discretionary portfolios back in the 1980s in the build-up to the market crash of 1987. When a change of direction was called for, my colleagues and I trawled through every single portfolio marking out the necessary re-balancing prompted by our strategic decisions. This certainly meant that every client received our individual attention but the process was fraught with stress and difficulty.

I recall many times when we worked through the night, collating all the dealing which we deemed necessary and which, in an ideal world, we should probably have done a day or two earlier had our systems allowed it. The problem was that any decision, say, to reduce exposure to Japan, which had fallen some 12%, in favour of an opportunistic exposure to Hong Kong, which had fallen more than 50%, involved a real decision on each client’s individual portfolio. This was because every single client had a slightly different Japanese exposure, depending on when they joined the service and which Japanese funds were favoured at the time. This scramble to re-balance portfolios rarely involved an examination of each client’s Capital Gains Tax (CGT) status because there just was not enough time to take that into account. This could always be justified by not allowing the ‘tax tail to wag the investment dog’.

The rise of the model portfolio
The result of that 1980s stockmarket fallout was a move by investment managers to convert these bespoke portfolios into ‘model’ portfolios, where clients with similar objectives and attitudes to risk held identical but suitably scaled portfolios. These were then deliberately managed for investment results and CGT was put to one side. With this new ‘model’ approach every single portfolio could be re-balanced in a trice because they were identical and could be managed via a simple spreadsheet.

Then in 1991 the unit trust regulations were changed, to allow collective funds which contained other collective funds to operate on a commercially viable basis. This was the penultimate step in the evolution of unitised portfolio management via portfolio-style funds. Compared with the evolved ‘model’ portfolios these new collective portfolios offered far greater economies of scale, much keener pricing (because of greater bargaining power) and complete freedom from CGT on underlying management. My firm ‘share-exchanged’ most of those 700 portfolios spread across three ‘models’ into three newly-constituted unit trusts launched specifically for that purpose.

The most recent changes to regulations have allowed collective funds to mix and match underlying funds and direct equity investment, as well as to blend a much wider range of asset classes. This means that contemporary portfolio-style funds can now comprehensively and effectively mirror and replace virtually any (far less efficient) individual, bespoke portfolio.

Trust in financial advisers
There may be very good reasons why the Singers should seriously entertain the advice of their financial adviser. The first is that a good local and personal investment management department can be met and ‘eyeballed’ by the client to offer regular reassurance about the style and substance of the management – there is far more accountability.

Secondly a good portfolio manager is not quite the same as a good fund manager. The portfolio manager is running portfolio substitutes and therefore has a keener eye on the overall risk aspects of managing the client’s money. The specialist fund manager works to very tight specifications regarding where they can invest and to what extent they can protect their funds by going liquid (the majority of specialist funds require the manager to remain relatively fully invested within their specialist area since that is the objective of the fund as specified in the prospectus).

A word of warning regarding the current obsession with performance tables. Do not be tempted to buy a portfolio-style fund based on performance tables. The job of a portfolio-style fund is to deliver safe and competitive ‘portfolio’ performance.

This means that individual constituents of the portfolio (the underlying holdings) need to be competitive within their own sectors, from a performance perspective, but the overall portfolio itself is meant simply to offer a sensible and rounded financial lifestyle solution.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 9th October, 2009 | Tags: Capital Gains Tax, CGT, IFA |
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