Are vertically integrated firms getting sub-advised funds right?

Vertically integrated firms could do more to ensure a fair deal for investors in sub-advised funds

While sub-advised funds, managed by another investment management firm than where the assets are held, carry the promise of lower costs for the end customer, data on funds run by the UK’s largest vertically integrated firms suggests that these may not always be passed on for the benefit of the investor.

With some of the funds ranking amid the worst performers in their sectors, critics say more scrutiny should be applied to the funds at some vertically integrated firms and how they decide on who runs their segregated mandates.

Digging into the data

If an adviser had client money in the Quilter Investors UK Equity Income II fund at the beginning of April, they would have been faced with returns of -22 per cent if they had invested three years earlier, compared to an average sector return of 28 per cent, according to FE data.

The fund, managed by Neil Woodford on behalf of Quilter, was at the beginning of April merged with another Quilter sub-advised fund – its UK Equity Large-Cap Income ran by Artemis Investors’ Adrian Frost. While the performance of that fund is better, its costs are higher, however.

The Woodford sub-advised mandate was part of the WealthSelect range, but has not been included since 2017.

The now-Artemis-managed fund had returned 18.2 per cent over three years, higher than the sector average of 17.6 per cent. But the move saw the total expense ratio paid by investors increase from 1.21 per cent to 1.25 per cent, and the new “fixed ongoing charge” grew from 0.75 per cent to 0.80 per cent.

Before the merger, the Quilter Investors UK Equity II Income fund had the same fixed ongoing chargeof 0.75 per cent as Woodford’s in-house equivalent fund – which remains suspended – but a marginally lower total cost of investing at 0.95 per cent.

See Neil Woodford’s latest columns for Money Marketing

While cost is one of the most commonly cited benefits of running segregated mandates, another is the ability to make changes as market
and individual performances change.

A Quilter spokeswoman said at the time of the merger that “while the fund groups and strategies for our sub-advised mandates are chosen with a long-term view, the process has the flexibility to add, replace, or remove fund managers where necessary.”

She hinted at another commonly cited advantage of the sub-advised fund structure: the option to switch manager quickly.

But are vertically integrated firms really kicking out underperformers when they need to, and how are they weighing up these options when it comes to protecting investors?

Taking the tough decisions

According to Shore Financial Planning director Ben Yearsley, investors in the segregated mandates wouldn’t have to face suspensions, unlike investors in Woodford’s own fund.

Yearsley says: “There isn’t any reason why those funds should be suspended, as they will all be advised sales. But I suppose it would have depended on whether St James’s Place or Omnis [which also run Woodford segregated mandates] had made a call to sell the fund, which all advisers then had to automatically follow.”

While not having to suspend a sub-advised mandate is beneficial in that investors are not locked in, it also misses out on temporary gates to ensure adequate liquidity when it comes to selling unlisted holdings; some commentators have praised Woodford’s suspension as a necessary evil to ensure the fund’s long-term future.

Despite passing the £90m mandate to Frost, Quilter did not wash its hands of Woodford completely, as it made a point that clients will still have choice of exposure directly to his fund (this was at the time of merger, prior to Woodford’s fund suspension), and also to his asset picks via Quilter in its in-house funds.

Two weeks after Quilter’s parting of ways with Woodford, Quilter’s Cirilium multi-asset active range managed by Paul Craig bought a 13.56 per cent stake in the investment trust P2P Global, at the same time as Woodford was on a selling spree, including out of P2P Global.

Quilter now says that “while the [merged] fund may be substantially similar to the Woodford Equity Income fund, it would not be identical in terms of the assets held, for instance, the fund may have different exposure to unlisted securities.”

According to Quilter’s website, the new fund’s objective is – like the previous fund’s – to achieve a combination of income and capital growth, but it makes a distinction in how it will achieve it: by primarily investing, directly or indirectly, in shares of UK companies, which are domiciled, incorporated or have a significant portion of their business in the UK, even if listed elsewhere.

Following the crowd

Although the Quilter Income Equity fund underperformed for a long period, the company did not close the fund until April this year.

The move was followed by similar ones by peers SJP and Openwork, which also run in-house funds managed by Woodford, at a time when outflows from the Woodford fund were making headlines, and when his own flagship fund was ultimately suspended.

In May, SJP chief investment officer Chris Ralph told the Financial Times the company was monitoring the fund and was “more intently focused”, but would not be withdrawing the mandate from a manager it had had a working relationship with for more than two decades. This was followed two weeks later, however, by the company’s announcement of its decision that it would be withdrawing the mandate from the lauded stock-picker to “ensure its clients’ investments continue to be managed effectively.”

Rowley Turton financial planner Scott Gallacher says: “Given the negative press coverage I think it was inevitable that Woodford would be removed as the manager from those other mandates. This isn’t necessarily to do with his ability as a fund manager but a sensible precaution from those providers to reduce their risk of significant redemptions and limit any potential reputational damage.”

While SJP’s giant £3.5bn mandate underperformed over the past two years, again, the funds managed by Woodford for SJP differed from his own fund, which had exposure to unquoted, early-stage companies. His SJP mandate limited him to picking stocks listed within the FTSE 350 companies, alongside a 20 per cent overseas flexibility with a $5bn market cap.

Is the absence of unlisted stocks the main reason SJP’s equity income equivalent, managed by Woodford, performed worse than Woodford’s own version?
Yearsley says the underperformance was likely due to fees.

Funds in the SJP mandate have higher charges than Woodford native ones. The SJP UK High Income fund has an OCF of 1.66 per cent, while the SJP Income Distribution fund has a TER of 1.90 per cent (and 1.50 per cent annual management charge).

Yearsley adds: “Another factor is that the large-cap holdings have also had a torrid time and are continuously priced whereas the unquoted stocks are only priced periodically.”

Another vertically integrated advice firm to strip the fallen-star manager of a fund mandate amid a storm of unpopularity, was Openwork’s asset management arm Omnis Investments. Its £375m Income & Growth fund, with an OCF 1.01 per cent, was assigned to Jupiter Asset Management, which already oversees the Emerging Markets and European Equities funds for Omnis.

Omnis said the asset manager was picked after “a selective process”, but would not comment on the criteria it used, or whether the new managers have made changes.
Back in February 2018, when Brewin Dolphin switched to a segregated mandate structure, the discretionary fund manager initially intended to hand the mandate for UK equities to Woodford, but ultimately opted for a different manager – saying that it made sense, as Brewin analysts downgraded Woodford in-house funds at the time.

Brewin Dolphin head of research Guy Foster says: “We review our fund list on a monthly basis, and so when we enhanced our managed portfolio service into segregated mandates, after careful consideration we decided not to give Woodford’s main fund a segregated mandate.”

The coming months will show, whether the newly assigned managers of these underperformers will bring the performance up. In the meantime, vertically integrated advice firms will continue to face questions as to whether the charges for their segregated mandates with star managers stack up.

Expert view

Portability and pricing are key

Segregated mandates do offer a huge price benefit to the wealth manager – this is sometimes shared with the end customer.

There are costs and overheads associated with unitising the mandate but for larger mandates, the delta between the cost to the firm and cost to the customer can be an important source of profit.
While asking what firms can do to bring down price to customers gets a lot of coverage in marketing and PR, there is little evidence that it is a core goal of mandates.

Brewin Dolphin is an important exception. They are using mandates in their model portfolios for a number of reasons. One of the benefits has been a reduction of cost to the customer.

Another benefit is portability. SJP and Openwork client money isn’t locked in Woodford’s fund. Both firms swapped the manager and both restricted holdings in unlisted securities.

SJP and Openwork had customised the mandate so it was not a mirror of the retail fund. They were able to change manager quickly. Even if they had not, their customers would not have been locked in to the fund unless the same issues of liquidity of holdings existed – which would not have been the case as the mandate had been customised.

Heather Hopkins is managing director of NextWealth

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Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. Derek Lambert 6th July 2019 at 6:36 am

    In the context of this article, what does sub-advised mean…buying without advice/non-advised at the point of buying a retail investment product or strategy followed/advice sought by the fund manager? As an industry, the use of unclear terminology is endemic – we really must do better.

    In relation to the paragraph “There isn’t any reason why those funds should be suspended…as they will all be advised sales. But I suppose it would have depended on whether St James’s Place or Omnis [which also run Woodford segregated mandates] had made a call to sell the fund, which all advisers then had to automatically follow” I don’t know where to start. What is the link between fund suspension, which is about liquidity risk crystallising in a limited range of scenarios, and whether a customer buys a fund as a result of a personal recommendation? So advisers will avoid funds with liquidity risk altogether and/or use a crystal ball to see the future? Second, an advisor has to automatically follow (whether in a VIF or otherwise) a call to sell – really? An adviser can only make a recommendation to their client which assumes some form of OAS is in place – which doesn’t exist in the majority of arrangements – and it must always come down to what is right for the client in terms of their personal circumstances. Surely no sane adviser, regardless of VIF status, would hop from one fund to another on an analyst’s day-so without considering the wider picture?

    Either I’m missing something fundamental or there are real issues with this article.

    • Daniela Esnerova 8th July 2019 at 7:11 am

      Hello Derek, thank you for your feedback! Sub-advised fund is a fund managed by another investment management company than where the assets are held. (So it’s purely about the way a fund is managed, not whether it is advised by an adviser or not.) I hope that clarifies your second point. I now see how “advised” could be confusing. I absolutely agree with you on your point re terminology, so I am sorry I now unintentionally contributed to that. I will add a definition in the article to make it clear. Cheers!

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