By Rob Griffin of Citywire

Billions of pounds have been ploughed into funds of funds over the past decade but they are not suitable for everyone.

The amount invested in such portfolios has rocketed from £23.6 billion to almost £108 billion in the 10 years to February 2016, according to Investment Association data.

This dramatic rise means their share of total UK funds under management has almost doubled from 6.8% to 12.6% over the same period.

While increasing in popularity as investors embrace diversification, traditional concerns about funds of funds, such as higher charges, remain.

Index replication

Andrew Merricks, head of investments at Skerritt Consultants, warns there is always the danger of paying too much for what may essentially become a tracker.

‘If the portfolio is widely spread across umpteen different funds you have too many holdings, and that effectively means you’re just buying the index,’ he said. ‘If a manager has seven UK funds, they’re pretty well replicating the FTSE All-Share.’

Merricks believes the situation is the same if you have five or six European funds covering different market capitalisations. ‘You’re paying for something that doesn’t actually work any different to the cheaper version, which would be a multi-index fund.’

He prefers to take sector, rather than geographic, bets. ‘Whether it’s biotech or cyber security of the European construction sector, we’d look for funds in specific areas rather than saying we want exposure to Europe or Japan,’ he said.

Even so, the rising popularity of funds of funds is hard to ignore.

Turbulence control

Investors’ enthusiasm for funds of funds is easy to understand, especially those that experienced the turbulence created by the financial crisis. They provide diversified exposure to a range of asset classes, sectors and geographies, and investors benefit from a manager making the key asset allocation calls.

Portfolios are also constantly rebalanced on investors’ behalves, while they also benefit from access to a wider range of assets, which would be tough to replicate.

Whether a fund of funds is suitable depends on whether it embraces a multi-asset or single-strategy approach, according to Adrian Lowcock, head of investing at AXA Wealth.

He said: ‘There are plenty of well-researched funds, so why would an investor have a fund of equity income funds when a maximum of two or three would do the job?’

However, he accepts these funds can have a role to play when it comes to delivering a client’s broader, multi-asset investment strategy.

‘You’re paying the manager who runs that portfolio to actively allocate assets, deciding how much to put into regions such as the US and Europe,’ he said.

‘They will also select the right funds for each sector and blend them into the portfolio, which for some people is a skill worth paying for.’

On the negative side, the charges levied by funds of funds can be considerably higher than for single manager funds.

It can also be difficult to gain specific exposure to particular asset classes so the full upside benefits can end up frustratingly out of reach.

Financial advisers and their clients also need to carry out more extensive research to see exactly how a fund is positioned, and to decide what environment it suits.

The pressure is on for managers in this area as they are expected to have a better chance of riding out challenging environments due to funds of funds’ investment flexibility.

Moving target

Gary Potter, Citywire + rated co-head of F&C Multi-Manager Solutions, agrees there have been a lot of changes in the fund of funds arena over the past 20 years.

Identifying managers that are building a performance track record rather than living off past successes is key, along with discovering those that are undiscovered or unloved, he said.

‘It is vital to be aware of tomorrow’s funds today and try to avoid funds that were once industry darlings but may not be as attractive as they once were,’ he said.