PRESENTER: For advisers outsourcing client investments to a discretionary fund manager, it’s important to get the right partner. One able to protect wealth, provide growth and a sustainable income, even if markets are volatile and yields are low. In this Akademia module, Laurence Forrester, Portfolio Director at Cazenove Capital discusses the investment approach behind a DFM proposition. This module covers the following learning outcomes: how an adviser can partner effectively with a DFM; the investment implications of pension freedoms; and the role of absolute return and alternative assets in client portfolios.
Well I began by asking Lawrence Forrester how an adviser should go about working out if a DFM is the right long-term partner.
LAURENCE FORRESTER: I think that’s a very good question, and just to give you some historical context I think had you asked me that question some 10 years ago it would have been a very simple one to answer. In that it would have probably been about reputation, about heritage. And I think that really the market has moved on now so that the answer now is actually quite a bit more complex than that. Now, why is it more complex? Well because the growth of the industry, both in terms of assets under management, and also the participants in the industry. That’s one factor. The other factor is the sophistication within the industry that’s been both led by the financial industry, but also by client demand.
PRESENTER: Well as you said there’s a lot more behind it than just pure brand these days. What are some of those other components?
LAURENCE FORRESTER: Well I think some of the things that advisers now look at, not just the reputation, although I do think the reputation and the brand of a business is still very much up there in the forefront of things that people look at. But I think from the perspective of delving into the industry a bit more, because of the demand for other types of investment strategies, more specialist investment strategies, and also the advent of technology and the advent of things like passive investments, it has made our industry have to take note of the way that the industry’s adapted and evolved, because of course we want to be part of it.
PRESENTER: So how important is the investment philosophy of the discretionary fund manager to what the adviser and their client are trying to achieve?
LAURENCE FORRESTER: Yes, a very good question Mark. I mean I think that from our perspective the investment philosophy is key, and I think that Cazenove has been for the last 20 years a multi-asset investment house, and I think that we were probably one of the first big wealth managers to go multi-asset. What we think has kind of backed up our desire to go into multi-asset is that a great many of our competitors have gone from being more traditional into something that seems more multi-asset. But that is our investment philosophy, our investment methodology. And what we see when we’re teaming up and partnering with investment advisers is that in fact they like a suite of different kinds of strategies. So they like a blend of different discretionary fund managers. And that is that they might want one that is more model based, they might want one that is multi-asset. They might want a more traditional stockbroker-y house, and then they might want one that has more specialist, more esoteric investment expertise. So things like venture capital trusts, enterprise investment schemes and so on.
PRESENTER: You say multi-asset, a lot of people call themselves multi-asset these days, what do you mean by that?
LAURENCE FORRESTER: Well, again, looking back circa 20 years, equities and fixed income were really the two asset classes that would call to any portfolio. And I would suggest that probably they still are. Now people would have equities and bonds in varying proportions depending on their age, because the old adage was of course that the older you got the more fixed income investments you have. Whether that’s still relevant is another question. But I think in terms of what we mean by multi-asset, and it has evolved, it has been an evolving process, is that what we wanted to do was to look at ways of mitigating the extent to which clients were exposed to vagaries of equity and bond markets.
Why? Well because equity and bond markets, as much as they can be responsible for wealth creation on a fairly fabulous scale. We’ve also found that throughout 2001/02/03, 2007/08/09, the start of 2016, they can also be responsible for wealth destruction. So, having other tools at your disposal we thought was no bad thing. And so investing quite heavily in things like private equity at the outset, things like absolute return funds, having in-house expertise in structured products, and then latterly and more recently expertise in things like renewable energies, asset finance, infrastructure, obviously commercial property but specialist commercial property. Those have all been things that we’ve bolted onto the proposition so that clients no longer have to pay a lot of money for income from the bond market, but also can look at other slightly more esoteric vehicles that can produce an income in their portfolios.
PRESENTER: Well, there’s a lot of other asset classes out there these days. Are they genuinely not correlated to equities and bonds, or are they just other versions thereof?
LAURENCE FORRESTER: Well I think only time will tell. The acid test of course is a proper correction. I daren’t say crash, because of course people watching may think that one is going to be immediately upon us, and of course that’s not the Cazenove House view. But I think certainly from our perspective when we look at how these assets are correlated, when you do look at the things that have recently come to market, so renewable energy, asset finance, aviation finance, it’s not to say that they can’t be exposed to the business cycle and the economic cycle. But I think that in terms of the exposure to the volatility, the equity-like volatility, I think that it will be significantly less.
Now, as I say, just to go back to my initial point, we have not had a really significant event. And God forbid that we do have another financial crisis. But I think that the acid test will be then, but my suspicion is that they will be considerably less volatile than equities.
PRESENTER: You were mentioning earlier about being a DFM operation, and then having set out specifically to provide a service to financial advisers. What’s different about providing a service to advisers and their clients, as opposed to direct clients?
LAURENCE FORRESTER: Well I think that what we want to give a financial adviser is really the accessibility to all of what Cazenove Capital and Schroders has by way of investment expertise. So we want to take that to their front door. So if it’s a one or two-man band. They may have 30 or 40 clients. What we want to take their door is that optionality that we can take to them that they can then offer their clients. As a one or two-man band of course the ongoing headwind of regulation. It might mean that the best that they can offer them is a platform solution or a managed portfolio solution. And that’s not to say or any way denigrate those solutions, but I think in terms of the more specialist areas, and I think that these are becoming things that clients want, and indeed looking at succession planning what the children of clients want.
The millennial alternative to investing in equities and bonds may be investing in things that have a more socially responsible investment kind of appeal, or ESG, environmental social governance, and/or social impact, and/or some of the alternatives that I’ve already spoken about, so renewable energies and those kind of things.
PRESENTER: And how easy is it to bespoke a portfolio for a client? Because you mentioned things that are important to them perhaps, like ESG or ethical investing, because there’s a bit of a view, maybe it’s a little unfair, a little cynical, that a lot of DFMs, essentially it’s an expensive form of a model.
LAURENCE FORRESTER: Yes, and there’s two ways of looking at that. One that you can take the cynical view and say well it’s just an expensive model. We would argue of course that that’s not at all the case. That you’re working within parameters. And I think the other thing that’s important to state, well if a model’s good then there’s nothing wrong with it. But I think that one of the things that you look at when you try and interrogate managed portfolio solutions is that they are fairly simple. There is a significant degree of simplicity there. Now, some people in the industry, you know, the people that are trying to find a low cost solution, do actually like the fact that things can stay simple. They might just buy a passive fund, or a collection of passive funds. And we think that there is some mileage in that as well.
But I think from the discretionary perspective, what do people pay more money for? Well they pay more money for a fund manager to go and eyeball them, to liaise with them, to find out what it is exactly they want to achieve. Are there any thematic inputs that they would like us to try and integrate into the portfolio? And moreover having talked about some of the specialist vehicles, it’s very difficult because of some of the liquidity within those products, to actually integrate them into a managed portfolio that could grow to several hundred million, several billion in size. What we can do for discretionary clients is actually do quite a lot of work around the core so that they have something that’s genuinely diversified, and also that something that fits their requirements.
PRESENTER: Now obviously we’ve had pension freedoms have been all the rage over the last few years, how does that change, or does it change the sort of offering that a DFM provides on the investment side, given that perhaps 65 is no longer the time to be buying gilts?
LAURENCE FORRESTER: So I don’t think there’s a great difference in how one should manage money within pensions, and I don’t think that necessarily pensions freedom has had any further implications on that, because of course when most clients come to see us they ask us, or they tell us that they want to make as great a return as possible for a specific amount of risk. And I don’t think that changes whether people are 55, 65, 90, if a portfolio can be a very long-term portfolio. Where I would say that there are still implications is if people need to draw down their pensions.
So if an individual who used to have a pension, who actually used to raid their pension because of the punitive tax regime on age 75 or death, they have since been funding their pensions, building their pensions up, because they know that they may be able to leave it to their children, grandchildren ad nauseum. What we’re saying is if people need to take a pension, then I think that it’s a very different kettle of fish. And when you look at the investment strategy within that pension that they’re taking, sometimes it probably needs to be a little bit more cautious than a very long-term portfolio.
PRESENTER: You mentioned earlier the importance of alternatives. How can they help you produce a significant but sustainable income, particularly for those who need that in later life?
LAURENCE FORRESTER: Well, it’s not necessarily just looking at the alternatives, but it’s looking at what they may replace in a portfolio. And I think that we have to be cognisant of the fact that buying income within the fixed income markets at the moment is very expensive. Even with gilt yields in, or treasury yields in the US starting to rise, within UK and Europe they’re still pretty low, and to buy a decent long-term income within the sovereign gilt, sovereign fixed income market is very expensive. So it’s not necessarily saying that we need to only have alternatives, but we need to have a certain proportion there to compliment what’s already there in terms of the fixed income space, and certainly until the interest rate or yield environment normalises somewhat.
PRESENTER: And I suppose the other thing is that we are used to the asset management, the discretionary fund management industry accumulating assets. Where’s the proof that DFMs have got a good track record in decumulation?
LAURENCE FORRESTER: Sure, and as per my answer a couple of minutes ago, I mean I really don’t see that the two differ. I mean people want to set you a mandate, and then for you to optimise the returns within that set mandate. If there is a line in the sand, or an age at which they say I really need to start taking my pension, this is when I want to start derisking in terms of the asset mix, obviously, we take that into consideration. But I think that in terms of decumulating, because of the fabulous way that pensions are structured, in that we can produce as much income or produce as much capital as we like without any tax consequences, I think that really the question of decumulation is one, and it’s almost a bit of a red herring.
I mean what we have seen within our industry is that some of our peers and competitors have started to put down, in terms of the availability of mandates to their clients, a decumulation strategy. When we look at it and interrogate it, we actually think that there’s not much difference between that and an income strategy, except that where some of them have put structured products in there. All it does is increase the risk to volatility and capital fluctuations, which of course if somebody is a pensioner and wants a fixed return at a fixed date, graduated income over the course of any one year, they probably then don’t want significant capital volatility.
PRESENTER: Well you mention volatility there as something that investors like to avoid. I’ve got a chart here, this is returns from some of the big absolute return strategy funds over the last, I think, there’s about 12 years there. But one thing is, there’s quite a range of returns you get from them, and there’s clearly quite a lot of volatility within them. How do you try and manage that in a portfolio?
LAURENCE FORRESTER: Well, if you have a spread of different funds, a blend of funds, then I think that what you can do is look at the track record, the manager longevity, the manager’s success, and say well if I’m to have two or three, or four or five of these funds in equal proportions. Look at the different strategies they employ, be it multi-asset or absolute return in the equity space, absolute return in the equity space, absolute return in the fixed income space. And having a blend of them should help to mitigate the extent to which they move together. What the chart really does show I think and encapsulates is how by mitigating and missing out large financial crisis and large drawdowns in equity markets that actually you can remain ahead of the game from the outset. And of course then you have to take less risk with the capital to achieve a long-term very attractive return.
I mean looking at this chart, the garish red line at the bottom is the FTSE All Share, and that’s a total return index, and that’s with dividends reinvested. And you can see that in recent years of course the equity market, as one might expect, has actually caught up some of the funds that have been slightly more either plodders or more pedestrian in terms of recent returns. But what that chart really is there to show is how if you control the extent to which you are losing money in really poor market conditions, then it just shows how you can perform over the long term and how attractive those returns can be.
PRESENTER: Well we’ve got another version of that chart. This is chart C. Which again I think is the same number of funds over the same time period.
LAURENCE FORRESTER: Absolutely, it is yes.
PRESENTER: Just showing the change thereon. But does this mean that people should expect over the long term that using absolute return funds they should beat equities?
LAURENCE FORRESTER: Well I think that that’s probably something that we couldn’t possibly say on film, and so I shan’t. But I mean I think the old caveat is that past performance is no indicator to future performance. What this shows is the journey over the course of the last 12 years, which if course includes the great financial crisis. It includes the first incarnation of the eurozone debt crisis, or Grexit as it was called. And it also includes the selloff in the second half of 2015 and early 2016 where you had fears of a hard landing in China, global GDP contraction, commodity prices falling. If you look right out on the right-hand side near the bottom you’ve got FTSE All Share, again total return. And then all the other funds to the left-hand side, one slightly below but most above. That is how those funds have generated returns, but also in terms of risk adjusted. And of course being a multi-asset investment house, risk adjusted is one of the key factors that we consider as our raison d’etre.
PRESENTER: You mentioned a little earlier handing on money to the next generation. How can you run a, how easy is it to run a portfolio on behalf of a family rather than an individual?
LAURENCE FORRESTER: Well it’s basically consultation with the family. I mean a good dialogue and a collaborative approach with the family and their adviser means that effectively we get to where they want to be. Now, in terms of the planning, and I don’t want to go too much into planning, but of course there are a myriad different ways that we can start. You can start with two SIPPs, which you could potentially manage together, or you could manage them individually and autonomously. You could manage bear trusts for children, which you could then manage as part of a family portfolio, and you could look at it holistically. Or you could split the portfolios so that each had their own properly structured autonomous investment portfolio. Or moreover when you get a planner involved you might look at other things, including family trusts or family investment companies. But again that’s a lot more the scope of planning than investment management. From an investment management perspective, there’s very little again that we would change necessarily in terms of looking at the next generation, until we know that that next generation is prepared to receive the monies.
PRESENTER: So from a purely investment point that point you were making a little earlier about absolute return investing approach, you would say that could be as appropriate for money being run on behalf of a 15-year-old as it would be for a 50-year-old or a 60-year-old.
LAURENCE FORRESTER: Yes, I think that what you’ve got to understand, and certainly from the perspective of the investment manager, is that we will follow the mandate that’s been set to us by either the client or the adviser. I think it’s still fair to say that a 15-year-old would expect to have very little by way of fixed income investments and absolute return investments within a portfolio. They might have a smattering, but ostensibly you would be investing in large cap, US equities, mid cap UK, and then having a fairly sizeable exposure to the rest of the world as well, the emerging markets, because you’ve got time on your side. I think where you need to look at more a multi-asset approach, and that’s not to say that it isn’t suitable for a 15-year-old. Because I think that you can certainly start to begin the process of education to that client, because that is an important part of educating the client. But I think that it’s going to play a less significant part in a younger client’s portfolio than it would in a fully-fledged client as it were.
PRESENTER: So when you’re talking to an adviser and a client, how do you make sure, I mean you’re all using the same language, but you all mean the same things by it?
LAURENCE FORRESTER: Sure, in terms of risk I always think that when you sit down with anybody when they’re talking about investments. They want to make as much money as possible with as little risk as possible. So one of the ways to slightly make it more compelling and slightly bring it to life for them is to assess their capacity for loss. So from the outset if you can speak to any client and say well how comfortable would you feel about a 10% loss in any one year? Some people will shrug their shoulders and say yes absolutely, I’d say invested. Some people will raise their eyebrows, and some people will fall off their chair and faint. I think if you’re one of the middle or latter, then of course what you’ve got to do is talk about the exposure to risk, and potentially the need to actually control it within a portfolio. If someone’s happy with a 10% loss in any given year, and happy to stay invested, then of course you know that they’re a long-term investor, and they can probably stomach the volatility that could be inherent in any investment portfolio.
PRESENTER: And one thing, I suppose, and you’ve touched on it there, is when you’re, the money’s being run for you, you want to judge how well it’s doing, so this raises the whole issue of benchmarks and absolute returns. What are the pros and cons of having a benchmark relative approach?
LAURENCE FORRESTER: Well I think that it’s again in integral part of how DFMs are chosen by advisers. They want to know that given a certain amount of risk that’s being taken with any portfolio, that you as a DFM are outperforming your peers, or an average of your peers. So I think certainly the advent of the use of ARC over the last 10 years - the asset risk consultants - has been really quite an interesting one. Because no longer are wealth managers wedded to what was formally felt as a conceptual benchmark, 50% equities and so on and so on. Now you are benchmarked on a graduated exposure to volatility, so percentage volatility of the MSCI Global. And of course what that means is no matter what we call our balanced, and what somebody else calls their balanced, actually they’re being assessed on the same basis. And that is how much volatility are you exposing a client to for any given rate of return?
PRESENTER: So for you volatility is a really good measure of how to put portfolios together.
LAURENCE FORRESTER: Absolutely. I mean and I think that in terms of the use of multi-approach, one of the key premises there was actually wanting to, and I think I touched on this previously, not being necessarily exposed to the vagaries of what equities and stock markets do, but actually building a portfolio that produces a steady long-term risk-adjusted return that’s attractive to clients. Because I think that actually when you talk about investing in equity markets, 100% equity portfolio, and you say well yes the portfolio went up 30% and the S&P went up 25% last year, didn’t we do well? Clients will say yes, well I made 30%, so I don’t really care what the S&P 500 did. But if the portfolio falls 30%, and you say well the S&P 500 fell 35%, didn’t we do well? The answer’s probably going to be a slightly different one, i.e. we still lost 30%, what have you been up to?
So again putting a portfolio together that’s well diversified, the whole premise of that was to try and smooth out the long-term investment returns so that clients feel I think rest assured that they can go and do what it is that they do whilst their money’s being managed and the custodian is a safe one.
PRESENTER: So how much do you think risk reward comes down to asset allocation as opposed to fund or manager selection?
LAURENCE FORRESTER: I think fairly significantly. I think that that has been, and there are many studies to suggest that that is the case. But I think that what is also important is that you have a robust due diligence process in choosing the underlying investments as well. Getting the asset allocation, OK we all agree that that’s a key driver of returns. But actually if you don’t have a robust process of choosing the underlying investments, then of course it could fall on its face. So certainly at Cazenove Capital what we have is a committee for each of the asset classes that comprise our investment portfolios. We have some committees that actually are for genuinely quite esoteric investments. And what they do is they act as a safeguard. They’re the people that see the wealth managers, the investment managers that want to come and sell their products to us. And they really filter out what they think is good, what they think is worth a second look, and then conversely what they think will give it a track record, let it get a track record, let them see how they do, and/or just avoid.
PRESENTER: But underneath that, what’s the role of active management? In this world that’s obsessed by fees, can clients afford to have active managers?
LAURENCE FORRESTER: Well I think when you look at the advent of passive fund management, and particularly we’ve had very exuberant markets for the last two and a bit years, and moreover for the last nine a bit years, it’s generally been a fairly exuberant bull market for most equity markets certainly. And so I would forgive people for looking at a DFM and saying well isn’t that a bit expensive, what have you delivered over and above what passives have delivered? My answer wouldn’t necessarily be well what have we delivered, because if you take it back one step it’s about what we may deliver if we do have another financial crisis. So not only do we stay close to our clients, not only do we make sure that we’re speaking to them, which a lot of passive managers don’t, a lot of MPS don’t. But moreover it’s about the control of volatility when the markets aren’t going up. And I think that’s why a great many people still have a really good founded faith in DFM.
PRESENTER: And how important is the underlying liquidity in what you invest in? I wanted to bring up this chart here, which is your diversified alternative assets fund, which I think is a pooled product that clients can use if they’re using the Cazenove Capital system, but I mean there’s a whole lot in there that are not necessarily the most easily tradable investments.
LAURENCE FORRESTER: Yes. Well that’s a very good reason for putting them in a fund. And again to talk about how this fund came to be, Cazenove Capital as you know was bought by Schroders in 2013, 4,500 investment experts globally. How do we leverage off that, and how do we pass on that expertise to our clients? So I mean effectively where we have specialist expertise, what we wanted to do was to try and give clients exposure to it. But I think if you are talking about an investment portfolio of say a million pounds where 5% of it may be in these non-correlating alternative investments, to have 30 or 40 different securities probably felt a little bit messy. As you’ve already alluded to, liquidity can be a concern within some of these investments for some people. I mean obviously that’s part of our due diligence process to make sure that there is sufficient liquidity. But by wrapping it up in a fund it makes sure that it’s tradable for each individual client.
I suppose the only way liquidity would be severely tested is if all of our clients wanted to sell the fund on one day. We genuinely suspect that that’s never going to come to pass. And one could also ask that about any other of the investment in a client portfolio, be it at Cazenove Capital or elsewhere.
PRESENTER: Sure, but in the round how highly correlated is that product, this fund, diversified alternative assets to a mainstream equity fund, or a mainstream fixed income fund?
LAURENCE FORRESTER: Well it’s been managed since last November, so it’s very difficult at this stage to say. I mean in the drawdown February to mid-March this year, actually the fund remained incredibly robust. It didn’t drop much beneath its launch level of 100p. Of course UK equities fell 10%, you had the subsequent recovery. So this fund actually enjoyed very little of the downside but has participated in some of the recovery. So it’s actually trading slightly above par now. What I would add is it’s not just about the capital value with this fund; it is also there to produce an income for clients. As I say not as a bond proxy, but as something that they can look at as an alternative stream of income.
PRESENTER: We are almost out of time, Laurence, but just pulling some of these strands together in the final couple of minutes of this Akademia module, what would you say advisers should really be thinking about when they’re considering a DFM provider that they can work with, and their clients can invest with over 10, 20, 30 years?
LAURENCE FORRESTER: Sure, well longevity, so track record I think is a huge factor. Brand, reputation, but I also think there are some factors there as well that are important. Because if you’re going to work with any discretionary fund manager you want to know that you’re taken seriously as an adviser. We’ve got a dedicated team that’s been set up for more than 15 years. It’s grown organically. As I said 10 years ago when I joined Cazenove Capital it was £200m under management. Now it’s more than £2½bn. Now, we don’t see that necessarily as just the success of the industry, we think that it’s about the success of the team, and also the support of our team by Cazenove Capital and latterly Schroders as well.
But I do think that we’ve got to stay relevant as well. And I think that it’s quite easy as a big company, as other big companies perhaps do as well to get complacent. We mustn’t, because there are a lot of competitors to us, a lot of start-ups, a lot of boutique investment houses. They’ve got people on the ground. They’ve got good performance figures. They’ve got something that’s slightly nuanced. And so I think that what we’ve got to do is stay relevant, stay competitive in terms of cost, and also stay close to our clients and our advisers and their clients. Because I think that complacency is something that could really hurt any business in this industry.
PRESENTER: We hear about fund managers and fund management groups that get too many assets, they’re not able to digest them and manage them. Is there a capacity constraint that can affect DFMs?
LAURENCE FORRESTER: Probably not. I don’t think there is in terms of the company itself. I think the perception of a company by advisers and their clients, I think that that can be something that sometimes you have to grapple with. I mean Cazenove is £35bn plus, the parent company is £450bn sterling. Sometimes we have to say to clients you are part of a big company that’s part of a bigger company, but you will still get the service that you deserve. You will still get a first class service that you would get at any small company, any boutique company. So don’t think that you’re not important. In terms of the assets, I think that there’s so much liquidity out there at the moment. And I’m not saying that again from a complacent perspective, because anything can happen. But I think that where there are liquidity constraints within certain investments, we have to be cognisant of them.
Why do we have to be cognisant of them? Because it can be something that implodes, and actually then really does hurt the reputation of any business. So why do we have those committees in place? Of course to make sure that we’re buying something where we think there may be liquidity constraints, that we’re either one of the first out if we think there’s a problem there, or indeed that we can liaise with the company to make sure that these things are dealt with properly.
PRESENTER: We have to leave it there. Laurence Forrester, thank you very much.
LAURENCE FORRESTER: Great pleasure, thank you.
PRESENTER: In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this module you should be able to understand and describe how an adviser can partner effectively with a DFM; the investment implications of pension freedoms; and the role of absolute return and alternative assets in client portfolios. Please complete the reflective statement to validate your CPD.