Pros & cons of investing in FoF unit trusts

A Fin24 user writes: Please advise on the  pros and cons  of investing in fund of fund (FoF) unit trusts.

Santhiran Naidoo, an investment analyst at Glacier by Sanlam, responds:

The expansion of the collective investment scheme (CIS) industry has seen the development of alternative investment vehicles for investors to consider.

Before weighing up the pros and cons, let's first look at these investment instruments.

Managed solutions

In addition to traditional single manager CISs, investors now have a number of “managed solutions” products available to them.

In the single manager approach, a portfolio manager/investment team will allocate investor capital among instruments primarily through direct investment. These portfolios would make direct investments into equities, bonds, property, cash instruments and even other CISs (an indirect investment) to a limited degree.

Managed solutions on the other hand provide investors with a portfolio constructed by making investments into single manager portfolios (into other CISs). The managed solution manager’s task is selecting the best or most appropriate CISs for the portfolio.

Before considering a managed solution, it is important for investors to distinguish between the options available to them. The three most popular managed solutions are fund of funds, wrap funds and multi-managed funds.

The following definitions of these managed solutions are taken from the Association for Savings and Investment South Africa (Asisa) website as well as Glacier's website.

Fund of Funds

An FoF is a collective investment portfolio fund that invests in other CIS portfolios. These could be funds within a collective investment portfolio management company's own range (internal FoF) or a selection of funds managed by various collective investment portfolio management companies (external FoF).

An FoF may not invest in less than two underlying collective investment portfolios.

FoFs are governed by the Collective Investment Scheme Control Act (Cisca) and are unitised portfolios.

Wrap funds

A wrap fund is a portfolio consisting of a number of underlying investment tools wrapped into a single product. The underlying combination of investment tools or instruments is selected to target the risk/return requirements of individual investors.

The wrap fund is not a CIS, but is rather a portfolio of separate CIS portfolios and money market accounts/instruments. Wrap funds are thus not unitise,d and each investor has direct holdings in the underlying unit trusts.

Wrap funds are governed by the Financial Advisory and Intermediary Services Act (Fais).

Multi-managed funds

A multi-manager approach resembles that of FoFs.  However, these funds use mainly segregated portfolios, but may have limited exposure (20% of assets) to CISs.

This approach generally uses external fund managers who are selected and combined into a portfolio. Multi-managed funds could be structured as a CIS, or could simply be a portfolio into which life companies or retirement funds invest.

Advantages and disadvantages

The major advantages and disadvantages of a managed solution product could be summarised as follows:

FoFs, wrap funds and multi-manager funds each has its own specific advantages and disadvantages, given their differing structures and regulations.

Ultimately as investors we have to understand the benefits and risks associated with choosing a managed fund solution. The question we should ask ourselves is whether or not managed solutions provide the expertise and diversification that justify the associated costs and risks.

In many instances, investors will not have the time, expertise or tools available to conduct comprehensive due diligences on fund managers and construct a portfolio of funds tailored to their needs. In such cases, placing the decision in the hands of a managed solution manager may be a viable option that could benefit the investor.

Alternatively, the investor could appoint a broker or financial adviser to select single managers as part of a portfolio. Of course this has an associated advice fee, but that must be measured against the costs and benefits of a managed solution.

While we do not advocate it, some investors could also construct their own portfolios or apply a combination of the options available to them without the use of a financial adviser. The efforts made by industry experts to assess fund managers both quantitatively and qualitatively should not be underestimated.

Each investor has unique circumstances and needs, so it’s not a one-size-fits-all product universe out there.

The trick is in understanding yourself, and then determining which of the available solutions best meets your needs.

- Fin24

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Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.
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