PlatformFeb 28 2018

A fund alternative to model portfolios

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A fund alternative to model portfolios

In interviews with advisers last year, Aegon UK found that 36 per cent mainly use model portfolios with their clients, which is down from the 41 per cent in 2016, according to a Platforum survey. This is at least partly due to the administrative burden and governance responsibilities associated with individual portfolios, according to the research. 

The Aegon UK survey also found a sharp increase in the number of advisers using a single, either internal or external multi-asset fund for clients, up from 18 per cent in 2016 to 36 per cent in 2017.

The fund approach can have positives for clients, including tax advantages and greater transparency, together with a more efficient operation and reduced administrative workload for the adviser. Importantly, advisers and wealth managers can use a fund structure, without necessarily moving their client money into an ‘off-the-shelf’ vehicle operated by a third party fund group.

Legal responsibility

For many businesses, unitising segregated client portfolios into their own open-ended investment company (Oeic) fund structure is now a perfectly viable option. 

Existing investment management arrangements can remain in place and an independent specialist can be appointed as the authorised corporate director (ACD), with regulatory and legal responsibility for the fund and its governance.  

The prospect of advisers moving client money into their own funds will, at a superficial reading, cause wariness among some, still mindful of past negative connotations around ‘broker funds’ and their multiple tiers of charges, eroding client returns. The unitised portfolio of today is a very different beast though. The costs of operating a fund and having it hosted on a full-service online platform now need be no more than those associated with running segregated portfolios.

Another key concern is that moving to a unitised structure means clients lose the transparency of having their own portfolio and will perceive this as a reduced quality of service. Latest platform technology can address this to a large degree, providing a ‘look-through’ capability, so that when a client looks at their portfolio they see through to the individual stock holdings, rather than just units in a fund.

Key questions

Unitisation will not be the answer for everyone, however, and there are a number of key questions a business will need to address to help decide whether this is the right path. The first step is to weigh up the advantages and make certain it is the most suitable option for clients. Part of this process is to consider the existing alternatives, such as external multi-asset portfolios, that are already available.

A sensible next step is to look at the value of client assets that would move into the fund. There are fixed or minimum costs that come with running a fund, such as depositary and auditor’s fees. Some £150m is seen as the minimum needed to make an Oeic economically viable. 

Less than that and the fixed costs would weigh too heavily on performance for individual investors. It is possible that a fund with much lower assets might be viable, but a higher level helps to protect investors’ interests.

The assets in each of the risk-rated portfolios are likely to become sub-funds of the Oeic and here around £25m would be a sensible starting level to make each sub-fund viable. However, if the required assets are not available, sub-funds can be blended to create the appropriate risk-rated options or to increase the range available to clients.

Key Points:

  • As the use of model portfolios tapers, advisers are looking to operating in-house funds for clients
  • In-house funds come with complexities but can offer tax benefits for clients and streamline administration for advisers
  • Operating an in-house fund will not be suitable for all advisers but could be viable for those with over £150m in assets under advice

It is also important to consider what type of assets will be held in client portfolios. There are restrictions on what Ucits funds can hold. They are not, for example, permitted to have direct exposure to property or gold. However, if necessary, a business could consider using a Non-Ucits Retail Scheme (Nurs) structure, which has fewer restrictions.

Some advisers will have highly bespoke client portfolios that might include items not eligible for a fund structure. In other cases, clients may hold shares in a company with which they have a specific connection. These may also not be suitable for an Oeic structure. However, there is the option of clients holding them separately, alongside their unitised portfolio.

If, after the adviser has addressed questions like this, unitisation still appears a sensible approach then the advantages for clients and the business can be significant.

Client benefits

When segregated portfolios are rebalanced, the sale of assets can trigger a capital gains tax (CGT) event. This is not the case within a fund, where transactions are sheltered from CGT. The liability is only triggered when the client sells their overall investment. This reduces the tax-reporting burden for the client (and indeed the business), while also allowing for more effective tax planning. Another cost benefit for clients is that investment management fees are free from VAT, unlike those on segregated portfolios.

Furthermore, clients have the reassurance that comes from the degree of regulation associated with funds and the governance that a good ACD will provide. They also have the benefit of transparent, published performance figures for the fund.

Advantages for the business

For the business, unitising portfolios enables a move away from higher individual transaction costs and restrictive investment strategies. It means rebalancing an entire sub-fund, rather than a multitude of individual portfolios; simplified reporting; and increased distribution opportunities.

The process of unitising portfolios can appear complex, but there are a number of specialist host ACD businesses to provide guidance at every step of the process, from the FCA application right through to producing all the literature required by the regulator, such as the fund’s prospectus and key investor information document (Kiid).

The ACD will shoulder responsibility for governance, overseeing, for example, investment management to ensure it is in accordance with the fund’s objectives and investment policies. It will also monitor areas such as liquidity and eligibility of assets. When appointing an ACD, the adviser can select the level of service that fits with their business model. Some ACDs will include a broader range of services than others. For example, some will provide regular briefings on regulatory change and update documents accordingly at no extra cost, while others will take a different approach. 

Some will perform virtually all tasks in-house, others will outsource. It is for the adviser firm, as fund sponsor, to judge which model best suits their needs. 

Unitisation will not be the answer for all adviser companies, but in many cases there can be significant advantages for clients and the business. This is particularly true of more sizeable companies, with larger numbers of portfolios, where one of the benefits is freeing up more time to spend with clients.

Martin Ratcliffe is associate director of IFSL Fund Services