October 31, 2017

In a Dynamic World, are Mutual Funds Becoming too Complex?

by Jake Moeller

Our financial services industry is to be commended for its ability to evolve and adapt. It is dynamic, innovative, and even exciting. Ongoing regulatory initiatives after the Global Financial Crisis have greatly improved the investment product-delivery chain, the quality of investor advice and product understanding has risen considerably and with an increasingly complex dynamic, fund managers are rising to the demands of transparency.

Do retail clients need institutional-type products?

I often wonder, though, if we are beginning to over-egg the pudding. Recently, I attended a fund-buyer conference where a fund on display was so complex that I was relieved to discover its structure and process had confounded not only me but a considerable number of the delegates.

Complexity in mutual funds isn’t new, but with the commensurate rise in intermediary understanding the seepage of funds primarily designed for the institutional domain into the retail space is common. Investors are seemingly becoming an army of asset-liability matchers and “life-stylers.” As a result product objectives are often deliberately vague, and industry and data classification schemes are battling to maintain meaningful like-for-like peer comparisons.

Products in “plain-vanilla” classifications are decreasing

Thomson Reuters Lipper data reveal that of the non-institutional funds launched in the U.K. so far in 2017, 8% are in Lipper’s Alternatives classifications. This figure was only 3% for 2012. Similarly, fund launches into the Mixed-Asset GBP Balanced classification have fallen from 10% to 5% over the same period. There have also been other patterns developing, such as the rise of funds within flexible, specialist, and unclassified sectors at the expense of funds classified in traditional “plain-vanilla” peer groups.

It is perhaps in the recent popularity of absolute-return vehicles that we see the largest array of complexity and diversity. Within the Investment Association’s broad TAR classification for example there are products from 19 different Lipper classifications drawn from currency funds, alternative equity market-neutral funds, and global macro-type funds, to name a few.

There are certain influences that demand more complex solutions, and the imminent retirement boom may be one of those. However, investors have always been retiring at some point. It’s not as if the retirement “glide path” is a new concept that cannot be accommodated with relatively simply designed products.

Does additional fund complexity bring better performance outcomes?

There is no guarantee that additional complexity brings favourable outperformance and volatility outcomes. For 2016 the average return on IA TAR funds was 1.9%, with a standard deviation of 0.5. Lipper’s Mixed-Asset Conservative GBP funds, by comparison, returned 8.6% with a standard deviation of 1.2. You try working out what is the optimal risk/ return trade off for that example. One thing is certain, additional complexity can potentially lead to an investor’s misunderstanding of what a product is trying to achieve.

Where additional flexibility gives a fund manager a better set of tools to generate returns, we have beneficial evolution. Where additional complexity for its own sake becomes a marketing gimmick or an attempt to dazzle fund selectors or investors, it’s probably over-egging the pudding.

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