There are many similarities between a multi-asset open-ended fund that invests using other Oeics and a model portfolio that uses similar underlying holdings. .
In both cases the investment manager will have the discretion to buy and sell holdings in accordance with the agreed mandate. There are key differences, however, and making the right choice can add value for a client. The investment objective of fund and model portfolios should be very similar as they will both be constructed to suit investors with the same attitude to risk and capacity for loss. Therefore, asset allocation, a major factor when creating portfolios according to appetite for risk, is also likely to be comparable.
A multi-asset fund is an open-ended investment company and, as such, is recognised as a separate legal entity governed by a trust deed which has been approved by the regulatory authorities. The trustees of the fund will also be regulated.
The model portfolio is not a separate legal entity. It is a collection of individual investments overseen by a manager who is authorised by their client to manage those holdings under a discretionary mandate. The model portfolio client is deemed to own each individual holding separately, while the multi-asset fund investor owns a share of the fund itself and the fund, in turn, owns the underlying holdings.
The investor’s lack of legal interest in the underlying holdings allows the investment manager of the multi-asset fund a degree of latitude when selecting investments. The manager is a professional investor and, providing the regulator is satisfied that the fund itself is acceptable for retail investors, the manager may select investments such as contingent convertibles that are only available to sophisticated or high net worth investors if held individually.
Depending on the size of the multi-asset fund, the manager may also be able to purchase institutional share classes that have lower charges than retail share classes. However, since the introduction of clean share classes, model portfolios have also been able to purchase similar cheaper priced holdings meaning that cost becomes less of a factor.
There are rules for a multi-asset fund that effectively govern the minimum number of underlying holdings and the maximum percentage of the fund that can be allocated to a single holding. While a model portfolio has no such rules, it is good practice that there is sufficient diversification.
The fact that a multi-asset fund is a separate legal entity creates a number of differences in the area of taxes and charges. The fund is exempt from capital gains tax (CGT) and may dispose of underlying holdings without crystallising a charge for the investor.
For the model portfolio client, each disposal of an underlying holding is a chargeable event and exemption from CGT will depend entirely on whether the investment account itself is exempt, as with a self-invested personal pension or Isa. Regular rebalancing of a model portfolio allows use of the client’s CGT annual allowance to increase the tax base cost and permanently avoid CGT.