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Impact Investing

IPE special report May 2018

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The unanswerable case for funds

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Just a few years ago it was still possible to achieve a decent global diversification by investing in the 10 or 12 most important financial markets. Nowadays you need to spread a portfolio across 30–40 financial markets to be properly diversified. On top of this, allocation by industry is also becoming a significant factor.
More and more markets are opening up around the world, and new investment instruments are being created all the time. Faced by this proliferation of choice, an increasing number of institutional investors are looking to investment funds to cover their needs. Fund providers are responding in turn by offering a greater number of sector and theme funds. They are also taking account of cost considerations by creating funds with low management fees (fees being the reason most often cited by institutional investors for not using investment funds).
Not only are institutional investors stepping up the pressure on external asset managers to reduce overall costs; the institutions themselves are also facing greater internal pressure to cut their own cost base. In this rigorous environment, funds are coming even more to the fore as ideal investments.
Over the past few years, our group has managed to convince more and more institutional investors of the advantages of funds-based asset management.
The following is a summary of the main arguments in favour of investment funds:
q Easy to compare the performance of different managers. Investment companies are obliged by law to publish the NAV of their investment funds on a daily basis. The NAV shows the manager’s net performance after the deduction of all management costs, such as transaction costs, custodian costs and asset management fees. Any deviation from the benchmark can be seen on the day it happens, and such deviations can be explained and understood by referring to the composition of the portfolio. Most investment fund companies are also adapting their performance reporting to uniform international standards. By contrast with the performance of many direct investment asset managers, investment fund performance is always transparent, it is accessible to the public and it cannot be manipulated. Consequently, most portfolio managers use an investment fund as the reference portfolio when making acquisitions. This ensures that the investment fund is always given the attention it requires in the daily management process.
q Savings on custody services. By buying investment funds, an institutional investor is acquiring a broadly diversified portfolio with low transaction costs. The investor’s portfolio statement will show only one transaction, despite the fact that the institution has actually acquired a whole range of individual securities at a single stroke. There are none of the delivery, payment and booking costs associated with direct investments. And because investment funds do not entail any of the hefty costs for collecting coupon and dividend payments either, cash management becomes cheaper and easier.
q Daily liquidity/market timing. If institutional investors decide to alter their asset allocation strategy, investment funds do not tie them to the kind of management agreement that often requires several months’ notice to cancel. Instead the institution simply sells its investment fund units at the daily NAV – one transaction, one price and no need to worry about whether the financial market or securities concerned will offer the required liquidity.
q Cost savings. Many institutional investors still regard investment funds as retail products. When comparing the cost of direct investments with investment funds, they still tend to use the maximum costs published in the fund prospectus as the basis for comparison. This is misleading. Firstly, many fund providers now offer institutional investors special subfunds with greatly reduced management fees and administration costs. And even if no subfunds for institutionals are available, most fund providers offer discounts of up to 50% of the costs charged to the fund on large transactions.
Add to this the savings which investors make on their own administration costs, and there is no disputing the unbeatable cost-effectiveness of funds-based asset management.
q Transparency. By working with a fund specialist, institutional investors are also guaranteed transparency at all times. Thanks to a professional global custody solution, institutional investors can always keep track of the value and composition of their portfolios. Furthermore, our reporting, for example, includes a regular consolidation of the positions held within the investment fund. These days, investment funds are completely transparent for funds specialists, and on request just about every fund provider can supply our companies with an up-to-date breakdown of the investments held by individual investment funds.
Daniel Häfele is managing director of Fondvest in Zurich

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