Funds of funds: How they can work for you

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BOITUMELO NTSOKO: Funds of funds have gained in popularity in recent years, but what are the benefits of these types of funds? How do they differ from standalone funds, and what are the pros and cons of investing in them? To answer these questions we’re joined by Richus Nel, who is a certified financial planner at PSG Wealth. Welcome, Richus.

RICHUS NEL: Hello, Tumi, and thank you for having me.

BOITUMELO NTSOKO: Richus, can you please explain to our listeners what a fund of funds is and how it works?

RICHUS NEL: Yes, Tumi. It’s in my mind a new-generation investment solution, and consists of a unit trust fund, a single unit trust fund which has underlying unit trusts – in many cases multi-manager unit trust funds inside of that one unit trust.

So you get one unitised investment solution, but underlying [it], instead of having different investment instruments in there – for instance, let’s say MTN or a Pick n Pay or whatever share is in there – it is more tilted towards including other unit trust funds, which have either got the same investment mandate or are built up on a building-block approach, let’s say a fund specialising in equity investments or in bonds, or in cash.

So one solution with a multi-manager underlying unit-trust solution.

BOITUMELO NTSOKO: And how do they differ from standalone funds?

RICHUS NEL: In the past advisors, all their clients or investors, would’ve picked their own unit trust funds. Now what you’ve got with this fund-of-fund approach is a dedicated asset or portfolio management team of professionals. They are skilled asset managers. They sit with all the relevant qualifications, the CFAs, the CAs, and sometimes there are CFPs in there. In the PSG fund of funds solutions, there are even engineers, there are MBAs, and there’s even a PhD.

So [those are] highly trained professionals with one sole focus. That focus is basically research and analysis to drive a particular outcome for that particular fund of funds.

So that mandate or the aim can be that that solution aims towards an inflation-plus-5% return outcome. And then all of that analysis, all that research, is then aimed to drive that particular sort of outcome for a client.

Now, in our case, it’s a qualitative process that is driven, and it focuses on the quality and the consistency of returns. What are they looking for in that consistency? They are looking for outperformance on a consistent basis, [such as that] of our peers, meaning the market average of a particular mandate but at a lower risk profile than the average, and at a lower cost profile than the average fund out there with a similar mandate.

BOITUMELO NTSOKO: And what would be the benefits of investing in a fund of funds?

RICHUS NEL: I think the main benefits are diversification and getting better or similar returns, but at a lower risk profile.

So what you are basically avoiding with a fund of funds is the under- and sometimes, I almost want to say, flash-in-the-pan outperformance of a particular fund.

[Instead] you’re driving a more sustainable and more consistent investment outcome for the client. It’s a lot more predictable.

So the financial advisor can really focus on prescribing the correct or the appropriate sort of outcomes or the solution for a client, instead of trying to design the recipe for their outcome. If you compare it to [going to] a doctor, doctors do not go and reinvent the medicine that they prescribe. They know that the prescription or medicine that they prescribe has a particular sort of result and cure and outcome, and they basically prescribe that appropriately for whatever situation is in front of them.

BOITUMELO NTSOKO: Richus, could you please share with our listeners how the underlying funds in the investment vehicle are selected?

RICHUS NEL: Again, I need to speak about the PSG Wealth Fund of Funds solution, because every business will have its own solution. In our instance, as I mentioned, it’s a qualitative process and a process that is fully documented.

I think that’s very important because, again, if you as an advisor – as the sort of the norm in the industry has been – drive your own portfolio construction, you are relying to a large extent on your own due diligence process and very little back-testing is done. If you don’t do any back-testing on portfolio construction, then surely there’s very little learning from mistakes or wins in the past as to what worked and what didn’t work.

So in our instance, this is really where the tyres are kicked. Obviously, the due diligence is an ongoing due diligence by the team of professionals. They look, for instance, at the investment philosophy of the managers they would typically include. They would look at the underlying personnel on those research teams and management-decision processes.

They would look at the decision-making process that they’ve actually documented. Is it appropriate? Is it solid? Is the implementation of their decisions in line with their process or are there discrepancies where they basically make decisions either in a hurry or where they are actually also driven by fear either of missing out, or fear of the market?

They look at particular details around the investment vehicle, then that the asset managers have registered, how it’s registered, and at the cost and tax structures of those investments. Then one of the main focuses is obviously choosing one of those underlying managers and product – the unit trust. You would specifically look at the depth of the liquidity in that fund.

So it’s a very comprehensive process, as I mentioned. For me, the big part is the reliance on the validity and the appropriateness of that investment process that’s been documented, and the reliance that I as a financial advisor can actually have to say, this is a process that’s been designed by professionals, reviewed by professionals, run by professionals and monitored. And there’s a very big reliance from a risk-management point of view as an advisor then prescribing that product solution to clients.

BOITUMELO NTSOKO: Richus, how do these funds of funds compare in terms of performance to standalone funds?

RICHUS NEL: It would be different in our case, the performance of these funds of funds. Again I think it’s a very big attribute that all the performance is on record.

So from the day of inception, these funds are registered as a normal unit trust fund. Every move that the committee and management team does is on record, versus let’s say a loose-standing fund portfolio construction where advisors will switch in or switch out funds, depending on what their own sort of research shows.

But the implementation of a fund of funds structure and changes to it is immediate. So you can directly compare a fund of funds product solution with [its] peers.

I can tell you, in our instance, these funds are then ranked in accordance with their peers, their specific industry and their mandate.

Basically, in our instance, our funds rank very high. In particular, if I look at our PSG Moderate Fund of Funds, and also the [Wealth] Creator, which is a one hundred percent equity portfolio, they consistently over five and seven years respectively are first-quartile funds.

So when they’re compared with their peers they are in the top quartile.

Our Creator Fund is 10th out of, I think, 170 funds. So the performance there is a high-performance return.

But also then we go back to saying that it’s coming at a level of consistency and at a profile of lower risk than [our] market peers. I think that’s what’s making it enticing from our point of view.

BOITUMELO NTSOKO: Richus, given that a lot of research and analysis goes into these funds, does that mean that the fees on these investment vehicles are higher?

RICHUS NEL: In our instance, as I mentioned, when these product solutions are put together, that management team of ours is focusing on the performance and the return profile of funds of funds; they’re looking at the risk profile. And then in the third year there is the fee.

So in our instance, all of our fund fees are lower than the average in their particular mandate, which I think is quite commendable.

First of all, one of the prerequisites of including a fund manager in our solutions is that if they have performance fees they actually have to waive them. I think that’s quite a big benefit. So no fund manager is in any of our solutions that charges performance fees, which makes the access into their funds in many instances a lot cheaper than going into these underlying managers directly.

And then for the last part, or two parts rather, there’s obviously an enormous economy of scale when you negotiate with fund managers with large investment numbers. It’s much easier to negotiate a better fee than going, again, as an individual investor.

And then, lastly, in these funds of funds, there’s also no double-dipping. So even if there’s a feeder fund that goes into one of our offshore fund product solutions, there are no doubled-up fees taken, let’s say, on the local fund, but also on the offshore fund. So, as I said, in all cases they are cheaper than the peer average per mandate.

BOITUMELO NTSOKO: You’ve mentioned quite a few benefits of these funds of funds, but what are some of the risks that are associated with investing in them, and how do you manage those risks?

RICHUS NEL: To my mind, Tumi, [there are no] additional risks, more than in any normal unit trust fund. So in the majority of cases, the biggest risk for a unit trust fund is liquidity risk.

In the industry I’ve seen some single or standalone funds experiencing liquidity challenges, in particular, some in the property sector with the great financial crisis – post that or owing to that. I have not seen the same challenges or the same risk in the fund of funds structure. I think it’s because of the diversification of the underlying managers. That makes it a very liquid and deep, liquid investment tool.

So in my mind, one of the biggest reasons, besides the outcomes that we are driving, is the financial plans that we are matching with a particular fund-return outcome – as I said, it could be at inflation plus 5%, or inflation plus 7% over a 20- or 30-year period.

One of the biggest reasons I use fund of funds is because it’s a very effective risk-management tool – and it’s a very predictable tool, which to my mind lowers the risk, instead of otherwise.

BOITUMELO NTSOKO: Richus, I don’t know if you’d be able to provide examples of successful funds of funds.

RICHUS NEL: As I mentioned, two of ours that are predominantly used are our local PSG Wealth Moderate Fund of Funds. As I said, it’s a first-quartile fund over five years, which is an appropriate investment horizon. That fund has come in over those five years. I think it’s ranked 37th out of 204 funds. So you can clearly see it’s [one] of the top-performing funds at a lower risk profile which I think is making it very attractive.

And then again, there is the 100% Local Equity Fund, which is PSG’s; it has an offshore portion, but it’s registered as the local equity fund, and it is a 100% equity fund, and it is ranked 10th out of 170 funds –which is quite remarkable.

That’s over seven years, so it’s a very remarkable outcome, considering that your building blocks are selecting other underlying unit-trust managers.

BOITUMELO NTSOKO: And what should investors consider [as to] whether this investment is right for them?

RICHUS NEL: As I mentioned, we are building long-term investment plans for clients. So our plans rest on a 10-, 20-, 30-year period. In that space, it doesn’t work to make investment decisions based on a one-year outperformance or a one-year underperformance.

I think to a large extent, when loose-standing funds are used to construct a portfolio by advisors or investors, I think they are constantly challenged with this matter – short-term underperformance. Is it now because of the market or is it because the fund has actually done something, something incorrectly?

So a one-year outperformance or underperformance to my mind is not part of the solution. It’s inappropriate, and obviously investment decisions based on that are skewed.

So in my mind, it brings a large degree of predictability. You can actually build the plan, but now you have a tool to accompany the plan. The other part is considerations [of], I would say, bigger investments.

If you’ve got a big investment amount, when these underlying fund managers are changed – and they are changed by these management teams for the right reasons, which could be a risk reason or a liquidity reason, or some other reason; not necessarily just the out- or underperformance – when those managers are changed, there isn’t a CGT [capital gains tax] implication for the client.

A lot of the time in a loose-standing fund portfolio construction, CGT becomes a stumbling block [in] making prudent investment decisions because that obviously affects the client’s cash flow.

Then [one of] the other two purposes that I can think about is emotion. If you know you’re an emotional investor – and that’s basically all investors [chuckling] like advisors, advisors are also emotional beings, just human beings – as an investor you are prone to [transfer] that emotion, either from fear of missing out or fear for the market, to your advisor. It’s a very difficult position you’re leaving the advisor with to manage.

If you transfer some of those emotions – and are prone to do that – I would suggest use a fund of funds solution because it creates a little bit of a separation between the person making the decision and the person sitting in front of you.

A lot of time that emotion destroys a lot of value.

If you are honest with yourself, considering that if you’ve forced an advisor before to either move in or out of the market or move more conservatively or more aggressively just because of that emotion we talked about, I think a fund of funds solution is superior.

The last part, just from a financial advisor point of view, [is that] in our instance PSG Wealth has created a premium product solution for us to implement, and we are facilitators of that, and implementation agents. In my mind that allows me to be a better financial advisor focusing on the client, rather than second-guessing the portfolio construction every now and again. We know the work has been done, we know it’s been done by professionals, and we know it’s monitored by that team on a continual basis.

BOITUMELO NTSOKO: Richus, just finally, if our listeners are interested in investing in a fund of funds how should they go about doing so?

RICHUS NEL: Tumi, the PSG Wealth Fund of Funds solutions are unfortunately accessible only to PSG advisors. So it’s an internal investment or a significant investment, from the business, in resources and skills and processes, etc, to equip those PSG advisors for giving a premium product out there.

I don’t know if that’s the case with other fund of funds solutions.

So in essence the message I want to get out today is that fund of funds portfolio construction is an automatic transmission of an investment vehicle, where before the loose-standing funds to my mind are a manual solution.

And I think this is the future of investment into unit-trust solutions for clients.

There are other fund of funds solutions, but in our instance only available through PSG advisors.

BOITUMELO NTSOKO: Just lastly, Richus, what is the minimum investment amount for these funds?

RICHUS NEL: There’s no minimum investment amount linked to the product solution. What you are linked with is obviously access into that solution, which normally goes through an investment platform. And in my mind that minimum is R1 000 a month. It’s a debit order and I think the minimum is a R50 000 lump-sum investment.

BOITUMELO NTSOKO: Thank you for joining us on this episode, Richus. That was Richus Nel, who is a certified financial planner at PSG Wealth.