In my conversations with clients, there is often confusion on what a Managed Portfolio Service (“MPS”) is and how it fits in with an investment strategy. Historically available to only very sophisticated or large investors, technology has made MPS more affordable and efficient for individual clients. MPS offers clients a variety of benefits including costs, risk management, diversification and downside protection. Let me explain why.
Independent Financial Advisors ("IFAs") have three choices on how they can manage investments for their clients; firstly, they can construct a client portfolio themselves, they can purchase investments researched by a third party for the client or, they can effectively outsource investment management to a third-party fund manager to either build a customised bespoke portfolio or utilise an MPS strategy. Clients, tend to be focused solely on investment returns which is understandable but there is confusion about the role of an investment manager and an IFA. In my opinion, clients can receive better outcomes when IFAs utilise an MPS manager.
The role of an IFA is much different than an investment manager and very few professionals can do both effectively. IFAs focus on calculating sustainable target retirement income, tax optimisation, inheritance tax planning, intergenerational wealth transfer, the growth required to achieve income to fund an objective, stress testing objectives, determining client capacity for loss and estimating the probability of a client achieving that goal. Whilst investment return is a key component used to determine an investment goal; it is not the only factor. Investment objectives are often missed because of a portfolio mismatch risk and because a client is simply not saving enough towards a goal. Within my firm, we utilise consultants to construct our in-house risk models which we then outsource to MPS providers to construct and manage portfolios according to a client risk profile. IFAs and an investment manager work together in this example. For transparency on fees, investment manager and IFA fees are disclosed so the client has a full view of what they are paying for. IFAs and investment managers perform different roles on behalf of the client.
By way of a simplified explanation, clients and investment managers have two choices when adopting any investment strategy, active or passive. When adopting an active strategy, the investment manager believes that their skill can yield a higher return than the market. The other choice, referred to as “passive”, aims to perform in line with the market return with a focus on reducing investment charges.
A criticism of active investment strategies is that they are more expensive than passive investments given that the costs of research, trading and human capital add to the expense of providing the service. Another widely held perception is that active funds underperform given that the skill of the manager is much more difficult to demonstrate because it is difficult for a portfolio manager to get an “edge” with all the information available within the public domain.
Passive strategies, depending on which sector or geographic area they are trying to replicate, attempt to produce the return of the market whilst focusing on minimising cost. Criticisms of passive investing are that they can underperform when costs are considered and an inability to take advantage of market anomalies. Most investors fall into the assumption that a passive portfolio can manage itself. The risks of a passive “Lifestyle Fund” where asset allocation automatically adjusts depending on client age have recently been highlighted in the media. A Telegraph investigation highlighted that a typical reader would be £90,000 worse off if their investments were automatically moved out of stocks into bonds by a lifestyle fund. In another example, one 59-year-old investor's retirement pot was reduced by £330,000 because their retirement portfolio was automatically de-risked. Another risk of passive investing is that funds typically invest in the same strategies with most money flowing into the largest companies as allocated which can lead to concentration risks. This risk can be highlighted when index weightings change or during market volatility. Many investors buy the S&P 500 on the belief that the index is well diversified which is not the case. In the case of the US stock market, The Financial Times recently highlighted that 26 stocks now account for half of the entire value of the S&P index.
MPS aims to blend both investment approaches by enabling investment managers to express a view and target outperformance whilst reducing investment costs. When building a portfolio investment managers can either construct a portfolio by buying the underlying investments or they can use funds that are already in existence. MPS, also known as a “fund of funds” strategy, does the latter as it buys index or unit trusts that are already established. Constructing a portfolio or investments that already exist offers several advantages for the investor that include lower costs by way of negotiated fees, downside protection and lower volatility with active asset allocation. MPS managers can manage investment strategies using a top-down approach by looking through what the underlying fund holds.
For example, my Firm currently offers over forty MPS strategies from four different investment managers and I have selected an example below. As you can see from this example the Fundhouse MPS has outperformed the passive Vanguard portfolio. The Fundhouse fund charge is 0.23% compared to Vanguard at 0.22%. Achieving an additional 3 per cent return over three years can be the difference between a client exceeding or missing their investment objective. In this example, the Fundhouse portfolio was only slightly more expensive (1 basis point) than the Vanguard portfolio and is invested in seven different index unit funds. IFA and platform fees are not included in the example below.
Source: Fundhouse 2plan Adventurous Passive as of 11/30/2024
MPS portfolios are typically only available through regulated investment advisor platforms largely because specialist investment firms can only deal with professional investors (IFAs). MPS needs to be offered on specialised advisor-led platforms such as Aviva or Aegon that link the custodian with the MPS advisor. As in the case of my Firm, clients benefit from negotiated platform discounts. Consumer direct platforms such as AJ Bell or Interactive Investor do not typically have MPS capabilities. When doing a portfolio change the MPS provider will execute trades from within the client account. This offers two primary advantages for clients in that it gives transparency to the client on what the MPS advisor is doing and that the assets are held within the client’s account at the investment custodian. In the case of my firm, all client assets are held by third-party custodians.
Peer reviewed by Stephen James – Chartered Financial Planner ACII APFS
Approval FP32922
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