Segregated mandates — possibly the most unsexy phrase you will come across all year. And yet, these boringly named contracts are becoming increasingly popular.
When wealth management firms hire a fund manager to run a bespoke investment portfolio for their clients, this is known as a segregated mandate.
Take, for example, St James’s Place (SJP), which hired now-defamed fund manager Neil Woodford to manage client assets across a number of funds in 2014. Woodford got into hot water earlier this year, which prompted SJP to sack him as manager of the £3.5bn mandate in June.
But while Columbia Threadneedle and RWC Partners were hired to replace Woodford for SJP’s funds, the investments weren’t completely unscathed from the scandal.
A spokesperson for SJP says: “We contract out the management of our funds because it gives us the freedom to choose the best managers from the global investment market, which are often only available to large institutional investors.
“We continually assess our managers and are well positioned to make changes quickly when appropriate.”
Of course, if an investment manager gets into trouble, the firm has to find someone else to run the segregated mandate instead, and this can be a complicated process, particularly compared to an off-the-shelf fund where you can simply sell it if it doesn’t perform as expected.
And yet despite this clear risk, more money is piling into these types of contracts. Looking across vertically integrated wealth managers and discretionary fund managers, research firm NextWealth estimates that there are £112bn in assets in segregated mandates. The company predicts that retail assets in segregated mandates will reach £190bn by the end of 2020. Meanwhile, some wealth managers, like Hargreaves Lansdown, are starting to use segregated mandates within multi-manager funds too.
And according to figures from the Investment Association, segregated mandates represented 66 per cent of assets managed for third party institutional mandates at the end of 2018, with the proportion increasing slightly from around 62 per cent when the IA began to collect this data in 2011.
Companies that commission these mandates can exercise more control over the investment decisions, laying down rules to meet their own needs. With SJP, for example, the firm restricts investments in unquoted stocks, meaning that fortunately, the segregated mandates were more liquid than Woodford’s own Equity Income fund was before it was suspended.
The other, arguably bigger, benefit is that management fees are cheaper than buying regular funds — though whether this saving is passed onto the end client is another question entirely.
Mike Barrett, consulting director at The Lang Cat, notes that wealth managers can potentially get some additional margin from these activities. “The commercial terms of the segregated mandate between wealth manager and fund group are never disclosed, so the wealth manager can set the fees paid by the end client allowing for some margin to be generated.”
And while the end customer can normally see the total cost of investing, it’s almost impossible to see exactly how this is divided between the wealth management firm and the fund manager.
Bearing in mind that pressure has been mounting for asset management firms to be more transparent (particularly when it comes to fees), the increase in this type of process seems like a step backwards.
Barrett also warns that if a fund manager is underperforming and the wealth management company can’t secure the same good commercial terms with someone else, the firm could decide to stick with the same fund manager even if they are performing badly. The danger then is that the company fails to act in the best interests of the end consumers, particularly if the customers aren’t actually benefiting from the reduced fees.
And even if the company does make the decision to switch managers, this model can make that process longer and more complicated.
“The segregated mandate will have a legal agreement which may include a notice period, and therefore it may take longer to replace the manager than it does when you buy a fund and simply have to hit the sell button,” says AJ Bell’s head of active portfolios, Ryan Hughes. “The incoming managers will often have to reposition the portfolio into the companies that they want, which can also take time.”
So should we be worried that huge amounts of money is being funnelled into these types of contracts?
“The jury is still out on the use of segregated mandates,” says Barrett. “The theory is that they deliver a better outcome for the end investor through a combination of improved governance and a lower cost of investing. There is a lot of evidence for the former, but not a lot for the latter.”
Barrett also points out that customers can’t hold these funds with anyone apart from their wealth manager, who created the mandate.
“With ‘normal’ funds, if you decide that you want to work with a different wealth manager, you can do so without having to touch your investment portfolio. But a segregated mandate could well mean that you need to sell out and invest into a new set of funds.”
In fact, Barrett warns that segregated mandates could end up being a barrier for people who want to switch wealth managers.
With billions of pounds going into these types of funds, and a lack of transparency around the fees and decisions, it’s certainly something that we should be keeping a close eye on.