Taking the New Road

Blue Chip speaks to Paul Fouché, Chief Investment Officer at New Road Capital about their Fund of Funds (FoFs).

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Paul Fouché, Chief Investment Officer, New Road Capital
Why should investors include Fund of Funds (FoFs) in their portfolio?

Most single strategy funds are designed with a specific investment philosophy in mind, for use in a broader portfolio. They tend to focus on a theoretical investment philosophy rather than considering behavioural factors that occur in practice. Hence many of them have significant tracking errors with higher volatility than their benchmarks and take on unnecessary risk to provide a small amount of alpha over time, often unsuccessfully.

FoFs are designed as holistic portfolio solutions rather than specific portfolio sub-components. Financial advisors can use FoFs to ensure that their clients are treated in a uniform and consistent way across their books and within their risk profiles and targeted outcomes. While Model Portfolios can do the same, they generally include an added layer of fees and trigger capital gains tax (CGT) within client portfolios if underlying funds are switched.

Additionally, their underlying fund allocations are limited by the specific LISP platform the model portfolio operates on, which results in a smaller investment universe when compared to a FoF that has access to any fund if it is regulated. It is for these reasons that we believe the FoF structure is superior to a Model Portfolio structure.

The more sophisticated client might also use a FoF as a core component to their portfolio which provides the basis of the portfolio and then add some satellite funds around this core for some additional exposure to a specific theme or sector for example.

And specifically, why include your FoFs?

We differentiate ourselves in two ways:

Firstly, we use a building block approach to portfolio construction, meaning that we use single asset class funds as underlying components in our FoFs. This allows us to strictly control our asset allocations to achieve our second differentiator, which is focusing on inflation plus outcomes. We structure our asset allocations to achieve these outcomes while minimising volatility. Hence, we focus on maximising portfolio efficiency from a risk-return perspective, and not solely from a return perspective.

We believe this type of strategy is desirable in practice because it increases the likelihood that clients will remain invested through volatile market conditions where historically those are the times that they make the emotional and wrong decisions of switching out of their long-term asset allocations. This usually happens if the investor’s volatility is larger than they are willing to endure. By managing the volatility, we believe the investor will have a better chance of staying the course.

Many FoFs and discretionary fund managers will use multi-asset funds as underlying components which we believe waters down any underlying asset allocation strategy. We don’t believe that this provides a coherent risk management value add to clients.

You offer FoFs across five risk profiles. Why are these a good option for the average investor?

Our solutions are designed for advisors to use throughout their client base and cater for conservative to aggressive clients. The underlying holdings across our solutions are similar but the weightings differ depending on risk profile. We have taken both financial advisors’ and clients’ needs into account and have tied our return targets to what we believe are realistically achievable over the medium to long term for a specific risk profile. These are similar targets that advisors use when conducting financial needs analyses on clients.

We have taken both financial advisors’ and clients’ needs into account and have tied our return targets to what we believe are realistically achievable over the medium to long term for a specific risk profile.

Aren’t FoFs quite expensive?

Traditionally FoFs have been expensive; however, with the advent of ETFs and other passive strategies it is possible to reduce costs significantly. We use a combination of passive and active strategies to achieve our targeted outcomes. We will generally only use active strategies where the risk-reward profile is favourable.

We are very proud that we have been able to offer FoF solutions with substantially lower fees than most of our peers. Our total investment charges (TICs) are in line with most single strategy funds on offer. So, the investor benefits from an added layer of governance and risk management without paying more than by just holding a selection of single strategy funds.

For more information, visit www.newroadcapital.co.za