As with any profession, wealth management has its own jargon for clients to get a handle on. Understanding these key terms will help to empower investors, wherever they are on their wealth journey.
Wealth managers fund selection is an important part of what they offer clients. This guide explains their typical process to select funds.
Wealth managers generally make extensive use of a whole range of investment funds in their clients’ portfolios. Diversification, market access, liquidity, transparency and cost-effectiveness are all potential benefits investment funds hold out and so it is unsurprising that many wealth managers have offerings which are exclusively fund-based. Some even run portfolios made up entirely of Exchange-Traded Funds.
Wealth managers vary widely as regards to how they construct and run investment portfolios for their clients and it is important that you understand how – and why – your chosen institution selects funds to invest your money in. This guide explains the typical process of wealth manager fund selection.
There are thousands of investment funds of various kinds for wealth managers to choose from (not to mention thousands of other collective investment vehicles within other structures like Real Estate Investment Trusts or Venture Capital Trusts). Institutions will usually have a rigorous selection procedure for picking funds since each one will need to suit your profile and objectives as well as having good prospects for generating returns. Risk management will of course be a top priority too.
There are many types of investment funds, but one of their most significant divisions is whether they are actively or passively managed; in the first case the fund manager (or team) will be trying to outperform the market by making tactical calls, whereas in the second the fund is run to mimic the performance of an index (or a particular basket of stocks in an index or sector in the case of “smart beta” strategies – something which might be interesting for those looking for something a little more sophisticated than “vanilla” passives).
Active management, as its name suggests, is much more highly involved and calls for a very high degree of skill. For this reason, active fund managers can enjoy near celebrity status in the investment world, although it should always be remembered that a fund or fund manager’s past performance is no guarantee of success.
This also means that actively-managed funds are typically more expensive to invest in.
Passive funds, meanwhile, simply allow the investor to simply and cost-effectively participate in the performance of any given index (and there are tracker funds covering virtually all markets and sectors). In contrast to a passive fund, an active manager will be regularly trading your portfolio and therefore incurring dealing costs which rise in line with this churn.
That’s not to say, however, that passive funds are always better because they are generally cheaper than active ones. The returns that passive funds deliver are in light with broad market rises (or falls), which is known as “beta”. Active managers aim instead to deliver performance in excess of the markets, or “alpha”, for a given amount of risk; generally, higher returns go hand in hand with higher risks and higher costs for the active investment activity required. For many investors, the promise of superior returns warrants a slightly more expensive choice of investment being deployed – although it should be said that you should always think about performance net of fees. Other investors simply want cost-effective access to markets and investment expertise. Your wealth manager will be able to take you through all the options that are available for your portfolio once they have met with you and understand your profile and needs.
Investment funds allow people to invest in assets collectively which they would perhaps find difficult to access effectively as an individual. Market access is actually a very important reason for using investment funds as a core part of your investment strategy since it really helps with diversifying your portfolios across different asset classes, geographies and sectors. This makes it less likely that all your assets fall in value at once. Your wealth manager can select funds for you which are run by specialist teams so that you can benefit from deep expertise in a certain region or sector. If your institution’s investment team believe that certain frontier markets have good prospects economically, for example, they could select a fund which invests in a diversified basket of stocks in those countries. They could even invest in a fund-of-funds where the portfolio is made up of underlying investments in a range of other funds, which is known as a multi-manager approach.
Investment funds are obliged to publish Net Asset Valuations and because units in investment funds trade daily on stock exchanges, they can offer a high degree of transparency over both performance and costs. There is a lot to consider when selecting funds, however. Your adviser will be well-versed in assessing the prospects of investment funds. This is essential, since simply looking at past performance is not necessarily a predictor of future gains. Indeed, in many cases top-performing funds have already peaked.
There are many excellent funds and fund management teams out there. However, there are lots of mediocre ones too – and worse. There are also funds which sensible investors should steer clear off and due diligence on potential investments is actually one of the most important responsibilities of wealth managers.
The investment funds your adviser recommends for your investment portfolio will usually be dictated from a top-down asset allocation view. This mean the way your asset base is divided among asset classes and sub-asset classes. Depending on the degree of standardisation prevalent at your wealth management organisation, your adviser could have quite a lot of freedom to populate the funds portion of your portfolio as they choose; equally, they may be choosing from a rigorously filtered shortlist of a couple of hundred or even fewer funds.
In either case, the funds chosen will be chosen for a highly specific purpose and will have been viewed in light of your portfolio as a whole, your investment objectives and risk profile, and, of course, the macroeconomic and funds research of the organisation itself. A professional will ensure that the fund or funds you are invested in are an appropriate match for your risk profile and overall assets. All too often DIY investors completely neglect things like correlation between asset classes completely.
A final consideration is whether the wealth manager offers clients a range of providers’ investment funds – known as open architecture – or whether it only offers funds which are run in-house. Proponents of the former would say that a best-of-breed approach to fund selection yields better results, while advocates of the second could argue that in-house funds create better control and risk management.
There are many factors to bear in mind on the subject of how wealth manager fund selection. While you certainly do not have to take an interest in the details if you do not wish to, your wealth manager will be ready to answer any questions you may have regarding their investment process – including how they assess and choose funds for your portfolio.
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