Ask Justin

Asked by rafferty, submitted 19 August 2010.

Changes to fund investment policy.

In April it looked a good time to switch a proportion of investment out of equity long funds so some was moved to the Standard Life Global Absolute Return Strategies R which had been having a good run. The performance since has been very decent: the SL GARS fund is 6% up whereas the FTSE is now around 10% down. (SL factsheet: http://uk.standardlifeinvestments.com/O_M_Gars/O_Q_GARS/getLatestOEIC.pdf )

I've now had a notification from HL that from 20 Sept there are to be changes to the fund's investment policy although I can't see anything about it on their website to point you to. In brief, they say that currently the fund invests in other collective investment schemes but now intends to move away from that to direct investment. They say the intention is to bring benefits to us investors from economies of scale but personally, until it's broken, I'd prefer they didn't mend it. Too often funds seem to run into problems if they get to large.

I wondered what your thoughts were and how these kind of changes tend to go?

Answered by Justin on 23 August 2010

The Standard Life Global Absolute Return Strategies fund (GARS) is one of the few absolute return funds that’s generally delivered what’s on the tin since launch (May 2008). It’s done so by investing around 60% of the fund in Standard Life funds (i.e. collective investments) and using the remaining 40% cash to bet on market movements across a wide variety of assets (e.g. stockmarkets, currencies, fixed interest and interest rates) using derivatives.

The underlying Standard Life funds provide a ‘core’ investment exposure across stockmarkets, fixed interest and property, while the derivatives are used to provide both protection and the potential for positive returns during falling markets.

Standard Life wrote to unit holders on 12 July outlining its intention to restrict the fund’s collective investment exposure to 10% from 20 September 2010, instead favouring direct investment in securities (e.g. shares and bonds).

If we assume that the real ‘added value’ on this fund is from the derivatives exposure, then moving to from Standard Life funds into direct investments should not pose much threat to performance. I expect funds will continue to be used for property and specialist stockmarket exposure, while direct investments will be used for mainstream stockmarket and fixed interest exposure.

But why is Standard Life trying to mend a machine that doesn’t appear to be broken?

I’d guess they either genuinely believe using direct investments will be more efficient and cost effective, or they’re concerned that the level of investment in their own funds via GARS is becoming too high (I reckon it’s already over £2 billion).

I suspect it may be the latter, as the underlying fund costs appear to be minimal (after checking with Standard Life). They confirmed that the underlying fund costs are not included in the 1.5% GARS annual management charge but instead charged as an extra expense to the fund which is included in the total expense ratio (TER). Given the GARS TER is 1.6%, only 0.1% higher than its annual management charge, this suggests the underlying fund costs are negligible (it doesn’t quite add up to me, but Standard Life have confirmed this is the case).

In general changes to a fund’s strategy tend to be a mixed bag. Some are eminently sensible, e.g. where a fund is clearly failing and strategy change could breathe a new lease of life. But on other occasions it simply signals an attempt by a fund manager to increase the scalability of their fund so that they don’t have to cut off the hand that feeds them by closing their doors to new business.

In this instance it looks like the latter, although I don’t see it as a particularly negative move. Provided Standard Life puts sufficient resource into direct investment selection then there’s no reason to suspect the fund can’t continue to deliver healthy performance. I think there’s a greater risk of performance turning sour due to the managers making some bad bets on the derivatives side of the fund rather than poor stock selection on the conventional side.

Nevertheless, rapid fund growth is always a concern as it places more strain on the manager. Provided they primarily invest in large, liquid investments then it may not be a problem – Neil Woodford has proved a large fund need not necessarily be a performance handicap – but it does invariably reduce a manger’s practical investment universe. The GARS management team appear to be coping well so far and I hope they continue to deliver, but I would keep an especially close eye on the fund over the next six to twelve months in case it shows signs of faltering.