A combination of regulatory change, the rise of passive investment products and the entrance of private equity into the wealth management industry have combined to create a world where vastly more investment capital is in the hands of a comparatively smaller number of fund buyers.
The consequences of this for the fund houses are that it has become harder to launch new funds, while for advisers and their clients, the risk over the short term is their capital is capable only of being placed in the largest funds, meaning potential returns are being missed from smaller products they cannot access for liquidity reasons.
Simon King, chief investment officer at Vermeer Partners, says there have been several pressures on the wealth management industry.
As the fund buying community has consolidated the minimum amount they can invest has risen dramatically Simon King, Vermeer Partners“The increase in operating costs for all funds, mainly around compliance and the general downward pressure on management fees, have pushed up the breakeven point for individual funds.”
He adds: “The second part is that as the fund buying community has consolidated – think SJP, Rathbones, Tilney – the minimum amount they can invest has risen dramatically. Most will have a limit of 10 per cent in any one fund and increasingly a minimum investment unit of £50m, so the fund needs to be £500m to be attractive.
"Individual teams at the big houses may use the discretionary element of their portfolios to ignore these guidelines. This explains why a few small funds that perform well initially rapidly accelerate their unit growth because the people that are limited at 10 per cent continually add to their holdings as the 10 per cent becomes a larger amount.”
The implications for a wealth manager of owning too much of a fund could mean it is more difficult to access the cash if they need to meet a redemption request, or the value of the investment could fall sharply.
Liquidity
Typically, liquidity is managed in open-ended funds through meeting redemptions by selling the units to new investors entering the fund.
If the level of new investors seeking to enter the fund is lower than the number seeking to exit, then the fund manager must begin to sell some of the underlying assets on the open market in order to raise the cash.
As the fund may have to sell lots of shares in individual companies to generate cash, this could drive down the prices of those shares, and mean the end client receives less for their investment than they may have initially thought.
Furthermore, if the underlying assets are not liquid enough to be sold, then the fund has the sort of liquidity mis-match that caused the Woodford Equity Income fund to be suspended.
Ben Yearsley, a director at Shore Financial Planning, says it should not matter if one owns a large slice of a fund, as long as the underlying assets held in the fund are liquid, as that should ensure a client can always get their money out in a timely and orderly fashion.
The Woodford Equity Income fund was stuck in lots of assets that were hard to sell, and with investors withdrawing cash at a much faster rate than it was going in, and being unable to sell the underlying assets, the fund had to be suspended.
As wealth managers invest in an ever smaller number of funds, so those funds will get larger.
Kelly Prior, investment manager within the multi-manager people team at BMO Asset Management, says one risk is that many funds need to be smaller in size to be able to succeed if they invest in niche areas, and the only way these funds can be both small and commercially viable is to charge higher fees than the industry average, but with the increased focus on fee level, and pressure on active managers to cut fees, the likelihood of such niche, successful investment products coming to market in future is greatly reduced.
Kamal Warraich, investment analyst at Canaccord Genuity Wealth Management, says it is probably best to access niche investment ideas, including micro-cap funds, through investment trusts rather than open-ended funds in order to have some liquidity.
Commenting on the broader question of fund size, he says: “Many wealth managers don’t want to own a large part of a fund because if they have to, rather than want to, sell out of a fund, that could damage long-term relationships with fund management companies, and with fund managers.
"What we are increasingly seeing is the big wealth management houses using segregated mandates to deal with these issues.”
A segregated mandate is a fund created exclusively for one client, with that client able to withdraw all of their money with just a notice period, and is not impacted by the flows of other clients.
Jason Hollands, a managing director at Tilney Smith and Williamson, which with assets of around £55bn is one of the largest fund buyers in the country, says: “If you are managing a sizeable book of assets for clients, allocating into a small fund where you might end up holding a substantial proportion of the assets could be problematic if at some point you wish to exit the fund.
"Having said that, discretionary managers will, however, sometimes be prepared to seed new funds where there is a degree of comfort that it is expected to scale up quickly. Seed money from discretionary managers via founder share classes has become an important source of support for new launches.”
Trust issues
Investment trusts seem to offer a solution to the liquidity conundrum, as they are companies listed on stock exchanges, so an investor can access the cash quickly by simply selling their shares on the open market.
But Yearsley says liquidity is an issue here as well, not because the shares cannot be sold, but around the price at which one can sell them. He says that it would be difficult to sell £50m worth of shares in almost any investment trust in one day without seeing the price fall markedly.
This has consequences for clients, as the earlier client may get a higher price than the subsequent one, even though they are in the same investments in the same portfolio.
Warraich is a little more optimistic than Yearsley regarding the ability to sell big lots of investment trust shares, particularly if the trust is £1bn in size or larger, but says the problem he has with allocating to smaller trusts is that often one cannot buy enough shares quickly for all the clients in a particular portfolio.
For King, whose Vermeer Partners is a much smaller business than the giants of the industry, the chance to buy investment trusts is one of the ways smaller companies can deliver better investment returns than some larger rivals.
But whether an inability to launch new funds is a problem for clients is itself debatable, says Yearsley, who contends that there are “already too many funds, we don’t really need any new ones”.
Hollands says there are too many investment trusts and so consolidation in that market would be “welcome”.
David Thorpe is special projects editor of FTAdviser
