There are two big reasons why advisers could be forgiven for assuming portfolio construction is all about asset allocation.
It’s an activity that has long been a major driver of returns, good or bad. On top of that, with many larger professional investors now using preset lists of funds they can use, picking the right product to execute asset allocation calls is no longer as big a part of the day job as it once was.
But it’s important to recognise that fund selection remains an important element of the process. This is particularly the case for both advisers and some of the discretionary fund managers to whom they outsource – and not just in the sense of picking managers who can beat the relevant sectors and benchmarks.
For nimble investors like advisers and some smaller wealth managers, picking outperforming funds that have been overlooked by most in the investment space is a good way to differentiate portfolios, and can potentially generate the greatest returns.
As Money Management’s first feature on small fund standouts discussed last year, consolidation across the retail investment space, spanning advice firms but also discretionary fund managers, platforms and asset managers, means that money is concentrated in fewer hands than it once was.
Larger wealth managers, in particular, now control too many assets to back smaller funds. Big players investing a meaningful amount of client portfolios in smaller strategies will quickly run into liquidity concerns.
Supply/demand
At the same time, there are still plenty of sub-scale funds out there. Morningstar research recently found that billions of pounds were languishing in “orphan” funds across Europe.
These orphans were defined as products with a track record of at least five years but less than €100m (£86m) in assets, and net fund flows of €10m or less in each of the five calendar years to the end of 2017. Nearly 200 of these 3,751 funds were UK-domiciled.
Morningstar added that almost 80 per cent of these orphan funds were underperforming, according to its rating system, a sign that many investors were being disadvantaged.
“The sheer number of these [orphan] funds shows the industry has launched far too many funds that are unwanted by investors,” the report says.
“And though the total level of assets in these offerings is small, our analysis shows that investors who have put money in them are often being disadvantaged.”
But not all smaller offerings lag in terms of performance. In an era of asset concentration and growing regulatory burdens, even outperforming funds can struggle to establish scale.
