There are mounting concerns over the concentration of fund flows in certain large funds, as the Retail Distribution Review creates a 'winner takes all' market among fund managers. Key fund selectors have started to impose size limits on the funds in which they invest, fearing that fund managers will ultimately be forced to compromise their investment process to accommodate the weight of assets.
Gavin Haynes, investment director at Whitechurch Securities, says: "The size of the fund has become much more of a key criterion within our sell discipline over the past couple of years. This has been due to an increasing concentration of flows towards a small number of funds, as centralised buy lists and DIY platform recommendations have increasingly influenced fund selection." Among others, groups such as Octopus and Rathbones have also highlighted the issue.
The problem is an unintended consequence of the Retail Distribution Review, which has led to financial planners increasingly outsourcing day-to-day investment decision-making to large brokerage groups, or to model portfolio providers. Buy lists have also become an important influence on fund flows. This has concentrated fund selection in the hands of a limited number of fund selectors and analysts.
These fund selectors will often have similar criteria for judging funds – consistency of process, tenure of fund manager, credibility of the fund management group – but only relatively few funds will meet these criteria, leading to homogeneity among model portfolios and concentration in a limited number of funds. Equally, these funds will also need to be large enough to accommodate the fund flows that a positive recommendation can generate. As a result, in seeking liquidity then can gravitate to larger fund groups that can provide them with sufficient capacity.
The phenomenon has seen funds such as the Silver-rated Schroder UK Opportunities fund (formerly Cazenove UK Opportunities) move from a few hundred million to £2.4 billion over the past three years. Axa Framlington Select Opportunities (rated Gold) is now £4.8 billion, M&G Optimal Income (rated Silver) £19 billion and its Global Dividend stable-mate (also rated Silver) at £8.5 billion. And Gold-rated Artemis Income is now £6.5 billion. Newton has seen similar expansion in its non-UK income franchises.
There is a question of whether this really matters. After all, it is logical that more assets should be concentrated in the best funds. However, inflows and outflows can create disruption in open-ended funds. Haynes says: "As fund selectors, we have to closely monitor whether increasing fund size is having a detrimental effect upon performance, due to liquidity constraints affecting how easy it is for a larger fund to buy and sell stocks in its chosen market. This is particularly important in less liquid areas of stockmarkets such as smaller companies and emerging markets."
This has been highlighted by the departure of Neil Woodford from Invesco Perpetual, which has prompted outflows from the group's Income and High Income funds. Both funds’ ratings are under review by Morningstar analysts. Other fund managers report being able to pick up assets cheaply that are being sold off to meet outflows. This is likely to create downward pressure on fund performance even in the hands of a talented manager.
High inflows can also create problems. Managers have to deploy inflows into the fund and may be forced to buy investments outside their normal remit. Some groups have tried to soft-close funds, but this needs to be carefully done, as a fund will often see a flurry of inflows after the announcement of a soft close.
For private investors, it is both a threat and an opportunity. There are funds that do not meet the needs of the larger fund selectors, but that will nevertheless perform well. These may offer the best opportunities for discerning investors.
Morningstar analysts award Gold, Silver, Bronze, Neutral and Negative fund ratings, indicating their belief in whether the fund will be the cream of the crop in future versus category peers, or a bad apple that’s set to underperform competitors.
