Is investing directly within an MPS a good idea?

From the GameStop standoff to the rise of newer platforms such as Freetrade, stock-picking appears to have returned to favour among DIY investors in recent years.

And they are not alone.

With cost pressures moving ever closer to the centre of clients minds, some discretionary fund managers have followed the path of other multi-asset specialists by taking up direct investing in their model portfolios. 

Once dominated by funds, some such portfolios now play home to direct investments in shares and bonds.

As mentioned, savage cost competition in the model portfolio space provides one explanation for such a trend, and DFMs are following in the footsteps of many multi-asset fund providers who had to adapt to their own fee pressures in years gone by.

But a number of other advantages come with going direct, alongside some more difficult considerations.

With many model portfolio ranges still sticking exclusively with funds, be they active, passive or a mixture of the two, having direct holdings can be one way to make a range stand out.

Part of this relates to conviction: an investment team could have substantial exposure to one stock that looks promising, easily building a weighting that may be difficult to establish via a handful of funds. 

That approach may well have regained some of its appeal in the last year; with much of the equity market struggling, just a few stocks and sectors have performed well, making niche bets look interesting.

The composition of many funds, be they active or passive, can make such targeted plays seem easier via the direct path.

Will Mcintosh-Whyte, a multi-asset manager at Rathbones and part of a team that turned to direct investing back in 2015, says that many funds still lack the precision investors might want in turbulent times. 

He notes, for example, of targeting regional exposures: “My problem with going ‘let’s allocate to UK equities’ is what are you allocating to? Is it the UK economy or the FTSE 100, which are very different things.

"The FTSE 100 might look cheap, but that might be due to its composition and weighting to oil companies. It [investing via funds] brings a layer of complexity because you lose the control of what you’re allocating to.”

Such regional quirks are already well-known to fund buyers, choosing a fund that tracks the US equity market or an active portfolio that is roughly aligned to it and you are likely to end up with substantial exposure to the big tech stocks, whether that was part of your plan or not. 

Elsewhere, Asian and emerging market funds have often a big weighting to China, while European indices have chunky exposure to banks, and global benchmarks such as the MSCI World are dominated by the US.

Those investors who have faithfully backed well-known 'value' funds might have spotted that such portfolios have had very divergent fortunes this year, highlighting just how different seemingly alike funds can be.

And yet such problems are not limited to more old fashioned benchmarks and funds either. ESG can be interpreted in many different ways, while company definitions mean funds dedicated to specific sectors will not always contain exactly what investors want.

The same applies to so-called 'thematic' funds, which target fashionable new phenomena and sectors from clean energy to space exploration. 

These portfolios come with a variety of issues, from those that hold a handful of extremely niche, potentially volatile smaller companies as a pure play on a given theme to those holding companies that seem to serve as a tangential play on the theme.

A team running a model portfolio range may therefore do better by picking a few stocks, or just one, that they view as the best play on a theme or as the best name within a certain area.

Mcintosh-Whyte argues, for example, that the development of electric vehicles stands out as “a structural trend with lots of longevity” but one that remains difficult for an investor to target. 

“If you wanted to do it through a fund there’s lots of thematic ETFs you can buy but you end up with exposure to original equipment manufacturers such as Tesla and Volkswagen.” His team prefers instead to seek out companies that serve as “picks and shovels” plays on this trend.

From DIY investors to DFMs, investing directly also appeals because of the degree of control involved.

While some funds, such as those in the Lindsell Train stable, are extremely concentrated, holding a handful of funds results in a huge number of underlying holdings.

That can be difficult to properly monitor or even understand, and some allocators may worry if they are simply taking an investment manager’s word that an investment is sound. 

To give an extreme example, former Jupiter manager Alexander Darwall had huge exposure to the controversial Wirecard in recent years and even continued to defend it not too long before the company imploded in 2020.

Control can also translate into taking opportunities in volatile markets. Take the huge moves in UK government bond yields in recent weeks: a direct investor would be able to take advantage of such valuations, rather than simply holding the likes of a strategic bond fund and hoping the team has the same mindset.

As mentioned earlier with value funds, a portfolio can sometimes behave differently to how an investor might expect. In theory a fund with direct investments benefits from greater transparency – if a stock plummets finding an explanation is often simple enough, as opposed to digging into the performance problems of a fund with dozens of holdings.

Expensive tastes

Fee pressure has certainly fed into the model portfolio space in recent years, in part thanks to the arrival of ranges that make full or substantial use of passives. Any chance to lower fees is welcome, and direct investing does recommend itself, especially at a time when many specific assets look 'cheap' in the wake of a heavy sell-off.

Having said that, DFMs may be right not to jump at the chance to pick out individual stocks or even bonds. 

Part of it relates to resources: Mcintosh-Whyte notes investing directly can be resource-intensive, something that prevented the team from going down that path when the Rathbone multi-asset funds were first launched. 

Another argument might go that stock-picking and fund-picking are simply different skills – one investor with a knack for balancing a portfolio by its style and sector exposures or identifying a promising new fund manager may well struggle to get their head around company fundamentals.

Some of the other arguments against embracing the direct route are well-known but worth repeating. 

Take, for example, the simple appeal of diversification available in a fund: even concentrated active funds will often have 30 or more holdings, while some (including passives) can have hundreds of investments.

If picking the right stock can pay off handsomely, diversifying properly can protect investors from amassing huge losses if a particular stock runs into trouble – something we saw in the Wirecard scandal.

Matthew Bird, of Falco Financial Planning, warns that greater unknowns can come into play for those going direct.

“It is possible to have greater concentration of holdings if you are investing directly yourself,” he says. “This can help as you can deploy more capital into your best ideas but it’s a double edged sword as with more concentration comes more risk. Ultimately the merit in a direct approach will depend on the degree of skill and also luck of the portfolio manager.”

Those running model portfolios may well find that greater communication is needed if they have significant exposure to a direct holding that does encounter problems.

One example might be the trouble in the bond market; while gilts certainly seemed to offer attractive yields already just a few months ago, they sold off heavily in the wake of the “mini” Budget of September, leaving investors sitting on some heavy paper losses. Any professional investor who has piled in may have to put in work to explain the dent it will put in future performance figures.

If investment teams might need to build out further expertise to buy the likes of stocks and bonds directly and monitor such investments, the rise of alternative asset classes may also guarantee greater longevity for the fund of funds mindset. 

Many investors remain desperate for asset classes that can offer diversification from equities, income or both, and all manner of options are now available, from infrastructure and property to music royalties and private equity.

A problem is that these areas are so niche, meaning many multi-asset investment teams would struggle to take any kind of direct approach.

Funds will therefore continue to appeal in this space, even if such asset classes have not acquitted themselves so well amid a rise in government bond yields.

With model portfolios built to offer broad options for investors with specific risk appetites, funds may continue to appeal most thanks to their level of diversification, with direct holdings serving as a better option for some bespoke clients.

Investment managers also run greater risks, and require greater resources, if they wish to start picking the best direct investments rather than picking out a spread of funds. 

But with cost pressure continuing to bear down and model portfolio managers looking to stand out from the competition, the direct route may well retain its appeal. 

That could ultimately lead into some big divergences when it comes to total returns and the level of risk being taken. Already faced with plenty of options, potential clients have another set of approaches to choose between as they decide where to put their money.

dave.baxter@ft.com