Broker fundS: A brokers perspective
Broker funds are often covered in the media, but they are up there with a certain emperor's new clothes when it comes to value for money. For an expensive rip-off, they are not doing too badly, though, says Louis Rossouw, Marketing Director of Quantum Wealth.
By December 2006, there were more than 250 broker funds in existence in South Africa, with combined assets representing more than 10% of the unit trust industry. Is this so because these funds allow brokers to earn more for doing less, or because they ultimately benefit the end consumer?
A personal perspective
From my personal (not necessarily objective) perspective, a number of benefits are clear. Better practice management (all my clients get equal treatment), speedy and simple portfolio adjustments, tax efficiency, and FAIS compliance.
As a firm believer in full and honest disclosure, I view the funds I use as revenue neutral, not a quick road to riches. Fee sharing merely alters the composition of the commission I earn, but not the amount.
Criticisms
Three key criticisms are usually levelled against broker funds: they undermine the giving of objective advice;they are too expensive; and they are managed by amateurs.
With regard to the first criticism, the truth is that in a free market, people mostly work to maximise profit. The profit motive should not, however, trump an Independent Financial Adviser's (IFA) basic function of providing sound financial advice.
Brokerages that strive to evolve into true multi-managers should seperate their financial planning and asset management functions. IFAs who use broker funds offered by someone else should evaluate such solutions in the same way as they would assess the asset allocation funds of any investment manager.
The second and third points of criticism, so argue the cynics, are borne out by the saga of British broker funds, which generally charged clients steep fees only to lose them a lot of money. There is no denying the devastating impact of high costs in a low-return environment, or the danger of allowing erratic wannabees to manage one's money.
Not all expensive
It is however simply untrue to claim that all broker funds are expensive. Underlying managers are mostly prepared to offer larger multi-manager funds institutional pricing. Provided the fees charged at the multi-manager level are reasonable, the total TER need not be more than 1.75% p.a., which is comparable with the international norm for "full" multi-management.
Smaller funds could find the going tough in a bear market, because they might not be able to negotiate aggressive fees from underlying managers, and they might not possess the requisite depth of portfolio management expertise.
Erring on the side of caution
A lot has recently been said and written about broker funds following overly-cautious strategies during a bull market, and the need for greater real returns as people live longer. Remember that people who do individual asset or liability matching seldom receive flowers when clients make money. They are, however, crucified when clients lose money! Hence the propensity to err on the side of caution. When evaluating broker funds, one should therefore use measurements of downside protection like the Sortino Ratio, rather than nominal returns.
Back to basics
In my view, there are a few simple questions in assessing a broker fund: What is the TER, who are the people who actually manage the money, and does the fund have a track record of strong risk-adjusted returns? Come to think of it, this is hardly rocket science – that is how IFAs have been evaluating asset managers for ages!
