Success of fettered funds kick-starts allocation debate

Success of fettered funds kick-starts allocation debate

The debate over fettered versus unfettered multi-manager funds has been reignited after a number of constrained vehicles appeared to outdo their peer groups in 2016, potentially due to lower costs.

A number of products that solely invest in funds from the same asset manager performed well last year, prompting suggestions that the narrower range of options available might have been an advantage in a year beset by turmoil.

In the IA Mixed Investment 40-85% Shares sector, for example, four of the five top-performing fund of funds – from Vanguard, Legal & General, BlackRock and NFU Mutual – took a fettered approach. 

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Three are passive products, but lower upfront costs are not the only reason for outperformance, according to some commentators. They believe that while unfettered funds have a wider choice of possible holdings, this could in fact be a disadvantage.

“Those funds with free rein ought to be better but that isn’t always the case,” said Mark Dampier, head of research at Hargreaves Lansdown. 

“Fettered funds do considerably less moving around. There is overtrading [in unfettered funds], but with fettered you don’t have a choice.”

Dan Kemp, Emea chief investment officer at Morningstar, concurred. “Fettered funds tend to have lower costs and hence a performance advantage,” he said. 

“A second source of outperformance is likely to be their contrasting approaches to asset allocation. My guess is that fettered funds tend to stick closer to a strategic asset allocation, while unfettered [products] tend to be more tactical.

“In a market dominated by the performance of index heavy-weights such as US equities and the dollar, strategic asset allocations tended to perform well versus a tactical approach.”

While the rise of ‘vertically integrated’ investment firms has seen fettered funds return to prominence, other investors’ wish for a wide range of investment opportunities has seen some asset managers move away from the products.

Last week Fidelity proposed to merge its £443m MoneyBuilder Global fund into another, much smaller multi-asset vehicle, citing the latter’s unfettered strategy.

Fettered funds had £60bn in UK funds under management as of November, compared with around £59bn in propositions with the freedom to invest externally, according to data from the Investment Association.

Not all are convinced 2016’s strong performers did well because of their fettered approach. 

Scott Gallacher, a chartered financial planner at Rowley Turton, highlighted that several of the funds that did well had opted for riskier strategies, and relied heavily on cheaper, passive strategies.

“At the top it is primarily fettered funds, but I think the reason they are at the top is they have higher risk scores and most are index trackers,” Mr Gallacher said.

“Last year high-risk [strategies] did well, and generally index trackers did exceedingly well. You could argue it’s a failure of active management as it is focused on return at a reasonable level of risk.”