Conflicts must be avoided if consultants launch FOF vehicles

24 Jul, 2013

Investment consultants considering launching their own funds of funds should make sure they avoid conflicts of interest, according to bfinance, the London-based investment consultancy.

This comes as Towers Watson announced it was intending to launch a smart beta-focused fund of funds, although the company says the product will shun high fees and over-diversification, while aiming to avoid excessive market correlation, and assets and liabilities mismatches. Towers Watson is also wary of labelling the product a fund of funds, for fear of the negative connotations it brings.  The firm is believed to be marketing this vehicle to its smaller institutional clients.

“Any consultant considering a foray into the funds of funds space must be careful to ensure they are not conflicted. This would mean they should only advise clients to buy into their funds of funds if they can show objectively it’s the most appropriate product, for example. They should analyse their track record in the space as they would an external manager,” said Chris Jones, managing director at bfinance in London, and a former CIO at a fund of funds.

Consultants were also advised to ensure their interests in these vehicles were properly aligned with those of their clients. “There will likely be concerns about aligning interests, so remuneration packages must be based around the fund of funds performing as clients would expect,” he added

The challenge for consultants electing to set up fund of fund-esque products will ultimately be to generate a decent track record. “Obviously, it is too early to tell whether they will be successful,” commented Jones.

The demise of the traditional funds of funds model is well documented. A Towers Watson study acknowledged that while funds of funds were offering customised portfolios and fee discounts, it expected further consolidation and liquidations to continue. A Preqin study revealed just 59 funds of funds launched in 2012, compared with 79 in 2011 and 142 in 2010.

The decline is further evidenced in Goldman Sachs’ latest investor survey, whereby funds of funds comprised only 35% of respondents, the lowest level ever recorded, and a far cry from 2008 when they accounted for 61% of those polled.

Several years of substandard returns and the additional layer of fees have deterred investors from allocating into these vehicles. Pension funds and insurers polled by Goldman Sachs said they would decrease their exposures to funds of funds by 26% and 54% respectively. However, sovereign wealth funds and endowments, told the same study they would increase their allocations to funds of funds albeit marginally.

Funds of funds, having spent several years re-inventing their flawed business strategy, instead opting to focus on niche and emerging managers, are showing signs of recovery. The HFRI Fund of Funds Composite Index is up 3.32%, barely lagging the 3.55% delivered by the average hedge fund. “It would be wrong to write funds of funds off completely as there are some excellent managers still out there,” said Jones. 

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