Managers seek out specialist niches

Active fund managers will be pushed to the farther reaches of the investment universe as they come under pressure from low-cost passive funds and a drive for greater transparency over fee structures, advisers are predicting.

Many investment advisers now say the future for actively-run funds is in niche markets as managers look for new ways to prove they can add value.

One of the biggest drivers for this shift, according to advisers, is the growing popularity of low-cost passive funds, such as index trackers and exchange traded funds (ETFs). Vanguard, the US fund manager, has recently entered the UK market offering the lowest-cost tracker.

With total expense ratios (TERs) as low as 0.15 per cent, these funds are attractive to investors.

The benefits of passive management were highlighted this week by Watson Wyatt, the consultants, which said the majority of defined contribution pension funds should use this investment route as it was more cost effective.

Against these competitive pressures, advisers say that active fund managers will look to new corners of the investment arena to show they can add value.

“Specialism is the way this may happen,” says James Norton, director with Evolve Financial Planning.

“For example, you now get more niche managers offering more esoteric funds attracting investors with the potential of huge returns.

“In the US, it is common to slice and dice a portfolio into myriad sectors and sub-sectors and it looks like the UK is heading this way with some of the offerings,” adds Norton.

Given these pressures, fund managers are also considering product innovations. “We are starting to see a lot of fund houses looking at alternative solutions such as trackers which have an active element, which allows them to go overweight in certain classes and outperform,” says Sheridan Admans, investment adviser with the Share Centre.

“Big fund managers who have a broad investment approach could switch to a specialist focus as they need to prove value . . . this might result in a shift to the emerging market areas.”

The economy could be another driver for change, with some seeing active managers moving into more specialist areas such as long-only alternatives – including hedge funds and tax-focused funds.

“Long-term returns are highly likely to be lower than over the past 30 years as the world economy adjusts to the new paradigm of lower interest rates and lower growth, thus putting pressure on costs to come down or returns to be significantly higher than the market,” says Jason Butler of Bloomsbury Financial Planning.

“Although the research does not support the theory that active managers do any better investing in less developed markets, the contention is more believable to investors and their advisers, thus supporting the proposition of some specialist managers.”

The shadow of the Financial Services Authority’s Retail Distribution Review (RDR) is also looming over the industry, which, under its proposals, must become more transparent about its fee structures. Under the proposals, from 2012, charges for funds will be stated in full so investors can see what slice of their fee goes to the adviser, the manager and the provider.

“I think the implementation of the RDR will be a big catalyst for change as it will allow investors to compare apples with apples, instead of apples and pears,” says Brian Dennehy, managing director of Dennehy Weller & Co, the independent financial advisers. “Fund managers will have to justify themselves more clearly against a passive fund. The better fund managers will emerge stronger as a result.”

Absolute return type funds, which aim to be uncorrelated with market movements, could be another area of growth. “These are the types of alternatives to long-only funds which are being discussed,” says Admans at the Share Centre. “They are discussing new ways to appeal to investors.”

The fund management industry says it is considering where its strengths lie, given the sudden loss of revenues it experienced when markets were in freefall.

“There has been evolution in the last year or so with the launch of a number of absolute return funds,” says Dick Saunders of the Investment Management Association, the trade body. “But this is quite a new development and it is in response to what investors are asking.”

But whether regulatory forces will lead to downward pressure on fees remains to be seen.

“The UK retail market has appeared to be relatively price inelastic so cutting charges doesn’t necessarily lead to an increase in volumes,” says Saunders. “This might change as the RDR leads us down a path of greater separation of the costs of advice and management. We will have to wait and see how this plays out.”

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