The biggest fund groups and funds seem to be getting larger as the industry appears to somewhat bifurcate into boutiques and behemoths. Why is this? Is it in investors’ interests and how are fund selectors responding?
Regulatory changes in the UK certainly have a part to play, whether it be the fee side-effects of the RDR, upcoming changes to how platforms can charge or general pressure on fees. Manager longevity has also had a role, in spite of some high-profile departures this year.
Fee pressure is prompting the deepest-pocketed firms to compete by cutting annual management charges, resulting in inflows at the expense of less profitable asset managers from those investors focused upon headline costs rather than the net of fee returns. As more end investors circumvent financial advisers this year and invest in funds via a ‘DIY’ method, so the costs of investing have become more transparent to them.
The rate of turnover of portfolio managers had been subdued until last year. For those that were successful, there was little need or desire to move in the wake of the financial crisis as their funds hoovered up assets and several were closed at capacity.
It is very important to realise that there are diseconomies of scale with regards to outperformance. Alpha is finite and erodes as assets grow. It is for this reason that smaller firms and funds can survive and why cheaper funds are often not the best performers. Arguably one often gets what one pays for.
As fund selectors, we invest with both large firms and small firms, large funds and small funds. Good performance can come from all types of funds and appropriate blending can also add value. There are, of course, different challenges in assessing large from small.
Regarding firms, fund selectors need to ensure that they are large enough to be financially viable or at least have a rapid path to success, but not too large that they restrict investment freedom and innovation. For example, we currently have money with IVI at the lowest end of the spectrum, right up to the largest money managers globally such as BlackRock.
With regards to funds, it is necessary to ensure that they are not too large so as to suffer liquidity problems and lack of ability to rotate through companies, but not too small that they are overlooked for new issues or not a core product for the firm with a clear future.
For example, at the moment, we have investments in the Artemis Income fund right down to the GVO UK Focus fund. The Artemis fund has been large for many years without hampering returns. Outperformance comes from stocks across the market cap range and the importance of the fund to the firm keeps the portfolio managers highly incentivised. It is interesting to note implicit succession planning given the co-manager structure there and the comfort that comes from the firm stating that it has a clear asset ceiling in mind.
The GVO fund has a long track record that has become increasingly strong over time resulting in accelerating inflows. In spite of a recent change of ownership, the firm is in good financial shape and it is especially pleasing to see a fund capacity explicitly stated in the prospectus.
Ian Aylward is head of multi-manager research at Aviva Investors
