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Choosing whether to invest in funds or in direct equities is a key question with a number of nuances that need to be understood, investment experts explain.

Investing in mutual funds has significant appeal as a way in for the beginner investor, and collectives may also form the bulk of many DIY-ers’ portfolios due to their diversification benefits, (perceived) lower costs and the convenient one-stop access they offer to sectors and markets. To underscore the ever-growing popularity of fund investing, asset managers globally run £48 trillion of investors’ money today across some 8,000 vehicles.

It is sometimes said that “true” portfolio construction through stock-selection has become a dying art amid the huge popularity of collectives and then passive investment vehicles like Exchange-Traded Funds, and an industry-wide need to contain costs as regulatory pressures continue to bite. A funds-based approach is typically far less labour-intensive and arguably this more cost-effective approach has helped wealth management services remain sustainable and therefore accessible at fairly modest asset levels. “The costs associated direct comparatively to offering a portfolio of funds is increasingly prohibitive for wealth managers,” said Dominic Gamble, Co-founder of and a former private banker.

Yet many wealth managers are still enthusiastic adherents of the direct approach and use funds only where there are compelling reasons to do so.

Reasons to go into direct equities

As one would expect, investment houses that favour direct equities tend to highlight the performance gains individual stock-picking can deliver (although achieving this with any consistency is of course no easy feat). But as well as the possibility of beating the market are a number of other possible reasons to invest directly, experts say.

“Going direct to market gives much more transparency to the portfolio because you know exactly what and how much you own in each specific company, and when you’re getting in and out; it can also cut down on costs by avoiding multiple layers of fees,” said Toby Thomson, Head of Sales and Client Relations at Henderson Rowe. “The other issue is liquidity. If you’re going direct to market you can get your money out very quickly, as opposed to funds or fund-of-funds.”

“Holding direct equites can help us to be nimble – in most cases, we can buy or dispose of stocks very quickly if necessary,” added Rosie Bullard, Investment Manager at James Hambro & Partners. We do not have to cast their minds back far to recall the “gating” debacles surrounding the financial crisis and later the regulatory drubbing of Traded Life Policies; we are also living in an uncertain investment environment, making such nimbleness highly desirable to many investors – and this may be along several lines. “Direct equities also of course make portfolio customisation far more practicable,” Bullard continued. “It can help if a client has a particular set of requirements, perhaps ethical, and wants us to screen out certain companies.”

And, as well direct equity investing removing the “middleman” fees represented by fund managers, Gamble also pointed to what might be a particularly important benefit for UK investors: Inheritance Tax reliefs. By investing in smaller companies listed on the secondary AIM market up to 100% IHT exemption is possible; in fact, many wealth managers offer specific IHT portfolios to maximise efficiencies through leveraging facilities like Business Property Relief.

Hidden risks

But perhaps more important than the benefits of direct investing is understanding the hidden risks present for those who aren’t vigilant about the underlying asset comprising their funds. Those investing without real discipline can find themselves uncomfortably exposed. In fact, as Artur Baluszynski, Head of Research at Henderson Rowe, pointed out, fund investors can fall prey to both concentration risk and over-diversification.

“Sometimes you see different funds holding 40% of their portfolio in same four or five positions. So if you’re in UK Income funds, you’re likely to hold Vodafone and British American Tobacco in most of them; on the other hand, some managers hold around 100 positions across the market,” said Baluszynski. “You can get both – being very highly concentrated in a few names or you can just own the market – in which case a cheaper option would just be to buy an ETF.”

Funds when called for

Simply buying an ETF is in fact a choice that most investment experts advocate in the right circumstances, and is one that both Henderson Rowe and James Hambro & Partners deploy for clients (along with funds more generally) when it seems cost-effective and sensible (this includes avoiding the more exotic, derivative-based vehicles). “We don’t see a point in over-thinking certain aspects of our asset allocation,” said Baluszynski. “If we can get a good and liquid ETF, then we will, particularly in some emerging economies where it’s very difficult to outperform because the market is driven by money flows instead of fundamentals.”

James Hambro & Partners follows a similar practical approach. “No-one has a monopoly on expertise and it is foolish not to take advantage of the specialist expertise of the world’s best fund managers – particularly in geographic or market areas where we can’t cost-effectively match or better that expertise,” said Bullard. “Funds definitely have their place.”

More broadly, there is no doubt that the maturation of the funds industry has hugely increased accessibility and expanded the investment universe for both institutions and the private investor alike. Inarguably, the funds industry has made investing more accessible and practicable generally. As Lee Goggin, Co-founder of explained, a balanced share portfolio with diversification across sectors would normally consist of 20-30 individual stocks – all of which have to be known in-depth. “If you are not keen to research individual shares and want to enjoy a better night’s sleep, then funds could be the answer,” he said. “Investing in funds helps to spread risk, give you access to a broad range of sectors and pool the associated transaction and management costs with other investors.”

“DIY investors have to ask themselves if they believe they can pick stocks better than a fund manager and can bear the burden of research, diversification and rebalancing long term,” Goggin continued. “Most people don’t and this explains the popularity of funds among DIY investors.”

A wealth manager might of course answer very differently if it is making a USP of its stock-picking prowess – as many are. Investors just need to ensure that this is predicated on things like broad research capabilities and experience in the markets, rather than aiming to “shoot the lights out” necessarily.

“Direct equity investing may well yield superior results once you factor in fund manager fees and sometimes lacklustre performance. The caveat is whether the expertise of the wealth manager is sufficiently deep to effectively stock-pick across the markets and monitor for all applicable risks,” Gamble concluded. “I would say that for most investors the focus has to be on consistently adding moderate gains rather than making big calls which might go sour. As any good wealth manager will tell you, it’s not about betting on black or red, but taking a more a disciplined, risk-aware approach to your portfolio.”

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