After four years of decline, net UK retail sales of funds-of-funds rose last year. Managers will hope that their mantra of product transparency and accessibility will continue to outweigh investor concerns over effectively paying two layers of fees.

Investment Association data shows that net retail sales for funds-of-funds in 2015 were £3.7bn, up from £3.1bn in 2014. Fund-of-funds assets represented 12.6% of total fund industry assets under management (AuM) at the end of last year, but a recent Fundscape report indicates that they punched well above their weight, securing 52% of industry sales in the first half of 2015.

While Jupiter and Schroders account for around a quarter of the UK market, Fundscape notes that the leading players by sales last year were 7IM, which has solutions that are popular with both advisers and retail investors (particularly its passive-based funds), and Hargreaves Lansdown, due to its captive distribution channel and effective marketing techniques.

According to spokesperson Danny Cox, Hargreaves Lansdown multi-managers are popular because they have a long and stable track record of outperforming their peers. “Funds-of-funds are broadly 0.5% more expensive than a basket of funds bought individually, so investors have to ask whether they believe they will get value for that additional cost. Compared to discretionary management services, 0.5% is very competitive.”

Multi-asset funds

Funds-of-funds fees have generally not come down any more than those of directly invested multi-asset funds. This is to be expected, as they have a second layer of fees to pay on the funds they invest in, observes Randal Goldsmith, senior analyst manager research at Morningstar.

When asked whether the fund-of-funds structure offers additional value to multi-asset funds, Goldsmith notes that in theory unfettered multi-manager funds (ones that can invest in external managers) have the flexibility to structure a portfolio selecting the best managers within each sector and asset class and to bring an added dimension of diversification by style.

Daniel Lockyer, senior fund manager Hawksmoor Investment Management, says it is unusual for a single fund management house to perform well across all asset classes, so the unfettered approach allows the firm to select the best fund manager for each asset class, geographic region or investment style.

Investor Association data also reveals managers’ increased confidence in internal funds. Almost one third of net retail sales were invested internally last year, compared to less than a quarter in 2014 and 26% in 2013.

“In practice, unfettered funds do not appear to bring a meaningful enhancement to a multi-asset portfolio’s risk-return profile and the selection of managers who repeat past outperformance sufficiently to overcome the second layer of charges is something many fund-of-funds managers fail to achieve,” adds Goldsmith.

Lockyer adds: “We believe there is a place for in-house funds for smaller-sized portfolios where it is more cost effective than a bespoke portfolio – provided the client agrees to this.” 

A well-managed, unfettered fund-of-funds that is run to a clear risk mandate and designed to meet client expectations can offer all the diversification of a model portfolio without any of the administrative inefficiencies of CGT, rebalancing, switching or delayed buy/sell decisions, according to Dan Russell, managing director of Verbatim Asset Management.

“This has been demonstrated recently by the post-Brexit suspension of property funds,” he says. “Many funds-of-funds have been able to weather this storm with little impact compared to the administrative hassle faced by firms implementing a model portfolio.”

According to Russell, the majority of research suggests that clients of financial advisers who purchase ongoing advice are not concerned about the mechanics of underlying solutions. “The decision around fettered versus unfettered is most likely made by the advisory firm at the point they design and build their client proposition and investment process. There is no right or wrong solution – just the extent to which they believe that further diversification beyond fettered funds is appropriate for their clients.”

Fundscape predicts that external funds-of-funds will outperform internal ones over the next five years. Assuming weak economic conditions, its expectation is that external fund assets will grow at an average compound rate of 14% in the five years to 2020 compared with 11% for in-house funds.