The growing demand for transparency, increased liquidity, fee structure changes, and lower stock-market beta products have increased competition in the sector. The classic fund of hedge fund (FOHF) model—offering investors “access” to a diversifying set of alpha managers, albeit at a higher cost and with reduced liquidity—is being challenged, especially where performance has been poor.

“During the GFC, many multi-manager/FOHF products failed to deliver absolute returns or diversifying protection from equity market sell-offs, raising significant doubts in investors’ minds as to the core value premise of the format. High profile due diligence failures compounded its unattractiveness, along with relatively high fee structures. In addition, some products using single-manager multi-strategy and active multi-manager models that incorporate tactical exchange-traded fund (ETF) and index-like allocations have outperformed the “alpha manager” FOHF model,” said S&P Fund Services analyst Michael Armitage.

He added: “We view the “allocate and pray” feeder FOHF model as dead. In future, we expect offerings that fail to compete in terms of active oversight, transparent risk management, product-level liquidity, and competitive fees to lose out to the growing competition from newer funds designed from the ground-up to deliver on these features. There were several upgrades in this year’s sector review as we recognised funds with some of these product advantages and gained conviction in other offerings that had shown extended track records since our previous reviews.”

The Alternative Strategies – Multi Asset – Diversified Multi-Manager And Multi Asset – Multi-Strategy Sector Report published today, together with reports for all funds rated as part of the review, are available on S&P’s subscriber website www.fundsinsights.com

We also withdrew our ratings on the following four headline funds:

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ETFs and exchange-traded commodities (ETCs) invest in a portfolio of securities, providing investors with diversification in a single transaction. They can be bought and sold on exchange just like shares.

The expanding range of ETFs and ETCs allows investors to gain exposure to Australian companies, overseas stocks, listed property, currencies and precious metals, including gold.

Tony Hunter, ASX Head of Education, said: “The new ASX courses explain the essentials of investing in ETFs and explain how ETFs traded on ASX work.“The courses are offered free and require no registration on the asx.com.au website. Users will find clear and easily understood information with practical exercises to reinforce learning.

“The self-paced nature of ASX online courses means investors can work through the courses sequentially or just select the topics that interest them.

”The seven short courses available cover:

• Introduction to ETFs – an overview of ETFs, their features, risks and benefits;
• What are ETFs? – a detailed course on the structure and strategy of ETFs;
• Buying, holding and selling ETFs;
• Domestic ETFs – ETFs over Australian sharemarket indices;
• International ETFs;• Exchange-traded commodities; and
• Synthetic ETFs and currency ETFs.

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ETFs were first offered for trading on ASX over certain S&P/ASX indices in August 2001. The sector has since grown strongly and now provides Australian investors with greater opportunity to diversify and internationalise their portfolios. The total suite available on ASX now stands at 55 with a combined market capitalisation of $5.1 billion,growing by 39% in the 12 months to 31 December 2010. For detailed information on the online courses click to view.

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The changes are part of MLC’s continuous assessments of its multi-manager strategies and are designed to further align the manager arrangements with the objectives of each fund.

Peter Sumner, MLC Investment Management’s Australian equities Portfolio Manager said, “Previously we have managed the Australian equities component of the Horizon portfolios and our Australian share sector fund as a single strategy. Both strategies employed the same managers with the same mandates.

“Going forward we believe clients’ interests will be better served by separating these strategies. The diversified funds and the sector fund play separate roles within a client’s portfolio and clients want different things from each of them. We therefore believe it is appropriate to separate the strategies, allowing them to respond independently to changing market conditions.

“Both strategies will retain their access to a suite of high calibre Australian equities active managers and will benefit from cost and tax efficiencies that MLC is able to achieve.”

As part of the strategy changes MLC Investment Management has terminated the mandates of Lazard Asset Management and Contango Asset Management. No new managers are being appointed and the portfolios have been reweighted across the remaining eight managers.

“While both the diversified funds’ strategy and the sector fund’s strategy will initially employ the same managers, the manager allocations for the two strategies and some manager mandates differ,” added Sumner.

Under the new arrangements each strategy will have the flexibility to make independent manager appointments, manager weightings and mandates as required.

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Zenith Investment Partners Pty Ltd (Zenith) Investment Analyst Steven Tang has announced the completion of the 2010 Fixed Income Sector Review and confirmed that from an initial group of 91 fixed interest funds, 7 were rated HIGHLY RECOMMENDED and 12 were rated RECOMMENDED.

In addition to being added to the Zenith Recommended List these 19 Funds are also candidates for client model portfolios.

The key changes to the Recommended List post the review include the addition of 5 new funds across various categories as well as upgrades for 2 existing funds. The 19 funds that were rated Recommended or above are shown below:

Australian Fixed Interest – Bonds

• Australian Unity Vianova Strategic Fixed Interest Trust (Recommended)
• Legg Mason Australian Bond Trust *NEW* (Recommended)
• Tyndall Australian Bond Fund (Highly Recommended)
• Vanguard Australian Fixed Interest Index Fund (Recommended)

Australian Fixed Interest – Corporate Debt

• Macquarie Income Opportunities Fund (Highly Recommended)

Australian Fixed Interest – Specialist

• Goldman Sachs JBWere Core Plus Australian Fixed Interest Fund (Highly Recommended)
• Perennial Tactical Income Fund (Recommended) International Fixed Interest – Bonds
• Advance International Fixed Income Multi-Blend Fund *UPGRADE* (Highly Recommended)
• EQT PIMCO Wholesale Global Bond Fund (Recommended)
• Vanguard International Fixed Interest Index Fund *NEW* (Recommended)

International Fixed Interest – Corporate Debt

• Colonial First State Wholesale Global Credit Income Fund (Highly Recommended)
• Bentham Global Income Fund (Recommended)
• Bentham Syndicated Loan Fund *NEW* (Recommended)

Diversified Fixed Interest

• Colonial First State Wholesale Diversified Fixed Interest (Recommended)
• EQT PIMCO Wholesale Diversified Fixed Interest Fund *NEW* (Recommended)
• Macquarie Diversified Fixed Interest Fund (Highly Recommended)
• MLC Diversified Debt Fund *NEW* (Recommended)
• Schroder Fixed Income Fund *UPGRADE* (Highly Recommended)
• Vanguard Index Diversified Bond Fund (Recommended)

Last year’s Fixed Interest Sector Report focused on the changing nature of Bond Indices and the effects this could have on future performance of fixed interest portfolios as well as the importance of maintaining Strategic Asset Allocation.

While these topics remain relevant today, this year Zenith chose to address some investor concerns, specifically whether to use diversified fixed interest funds or specialist sector funds and the veracity of the ‘Bond Bubble’ claims.”

The last few years have been a roller coaster ride for investment markets and investors alike. During this period many investors were understandably disappointed with the performance of their investments, particularly those they thought were defensive.

Unfortunately, many products labelled as diversified fixed income funds were among these defensive investments that failed to deliver on expectations.

Following this disappointing period it’s not surprising that many investors questioned their fixed income allocations. The natural question became ‘if the diversified offerings had failed to deliver on expectations would it be better to segregate the fixed income allocation and allocate to specialist managers?’

In response, Steven Tang offered the following insight, “While a simple portfolio construction exercise, in which mandates are separated and return data over the past few years is used, lends credence to the intuitive appeal of this idea (based on the presumption that these specialised managers have superior skills within their more defined mandates), the outcome is highly dependent on the investor making the correct initial and ongoing asset allocation decision.”

Although it’s simple in hindsight it’s historically a very difficult task to execute successfully and can dramatically change the outcome. Performance over the past few years by diversified fixed income managers has been more a reflection of their strategic benchmarks than their lack of skill in this area.

Given the changing fixed income landscape these managers remain better placed to exploit the diverse range of opportunity sets, alleviating investors of the complex asset allocation decision.

It’s for this reason that Zenith’s Recommended List and fixed interest portfolio exposures remain biased to Diversified Fixed Interest Funds.”

In reference to the debate concerning the existence and threat of a ‘Bond Bubble’ in the US Treasury market Steven Tang observed that using the typical definition of a ‘Bubble’, i.e. irrational market behaviour driven by speculative mania, it’s unlikely that the US Treasury market represents a ‘Bubble’.

Unlike other financial markets, investors know exactly what returns they will receive if they hold until maturity (assuming no defaults). Additionally, short-term gains are likely to be very modest given current yields. More likely investors are looking for a safe haven for their savings given their torrid experiences of the last few years and the current uncertainty in global financial markets.

Steven Tang concluded, “Nevertheless, it’s definitely possible that investors could face a capital loss as bond yields rise. However, while they may not remain at their current lows, it’s difficult to see a near term catalyst for a rapid rise in yields which would result in large investor losses.”

“In the future, US growth may surprise on the upside, the US Federal Reserve may maintain its loose monetary policy for far too long, creating massive inflationary pressures, or demand for US Treasuries could dissipate making US Treasuries an appalling long-term investment.

“But not in the near-term.”

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Key themes to emerge from the Sector Review

Stable resourcing

Managers have remained relatively steady in the diversified funds space, with the average investment team size of seven people. Deanne Fuller, Senior Investment Analyst responsible for this sector review, commented, “The size of the investment team in most cases represents the number of individuals having input into the asset allocation process. The number actually responsible for day-to-day management of the funds is generally between 1-3 people.”

“The great thing is the high level of investment experience of the people involved in managing diversified funds, with an average of 13 years’ experience.”

FUM increases, outflows continue

While overall, funds under management (FUM) has increased across the board, rising from $42.2bn in December 2008 to $52.2bn in December 2009, the majority of managers experienced outflows during this period.

“The increase in FUM is due to improved market performance rather than inflows, although a few managers did record positive flows, most notably index manager Vanguard, which experienced substantials flows totalling 13% of FUM,” said Fuller.

“Despite declining FUM, diversified funds continue to play an important role for investors (particularly those with limited capital to invest) and significant capital remains invested in them.”

Strategic asset allocations retain stable

There has been little change to the strategic asset allocation (SAA) within diversified funds since Lonsec’s last review. Australian equities continue to dominate asset allocations with managers allocating an average of 37% to the sector. Global equities form the next largest allocation with an average of 24%.

“While global property is considered to be a ‘mainstream’ asset among multi-managers, less than half of the diversified growth funds we assessed allocate capital to this sector,” observed Fuller. “Those that do allocate an average of 4%.”

From 11 growth managers Lonsec reviewed, seven now include alternative assets in the SAA. “Alternatives used include hedge funds, commodities, mortgages, infrastructure, high yield credit and inflation linked bonds,” said Fuller.

“The trend going forward is expected to be towards alternative assets with greater transparency and liquidity.”

Single manager vs. multi-manager

In a reversal of last year’s results, diversified funds have underperformed their multi-manager counterparts by 1% over the last year. Over longer time periods however, diversified funds continue to outperform due to their stronger relative performance during the global financial crisis.

“The global financial crisis highlighted the importance of tactical asset allocation (the ability to tactically under/over weight certain asset classes at various stages of the economic cycle) in quickly and efficiently reducing risk within a portfolio,” observed Fuller.

“Diversified funds (single manager) include TAA as part of their process and their ability to underweight equity market exposures during the global financial crisis lead to a significant outperformance of their multi-manager counterparts.”

“In addition, diversified fund returns have been achieved with lower levels of risk than equivalent multi-manager strategies over all time periods,” added Fuller.

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