Given that diversification is one of the most important principles of investing, we should question why the UK’s largest investment platform Hargreaves Lansdown doesn’t seem to be following this basic idea.
This became apparent in the wake of the scandal around Britain’s most famous fund manager, as £1.6bn was funnelled into Neil Woodford’s still-suspended fund via the Hargreaves platform – not only because it recommended the investment on its best buy list (known as the Wealth 50), but also because six of its 10 multi-manager (MM) funds are exposed to it.
Around 291,000 Hargreaves customers are invested in the poorly performing Equity Income fund, and are now locked in until December at the earliest, with no option but to pay the fees that Woodford is still insisting on.
But this problem isn’t limited to Woodford, as concentration risk could be an issue across other funds too.
City A.M. has found that at least 26 funds included in Hargreaves’ Wealth 50 list are also invested in the company’s MM range, showing a distinct overlap between the two.
All the MM portfolios have some exposure to the favourite funds, but eight portfolios have at least four Wealth 50 funds in their top 10 holdings. Take, for example, the £1.23bn Balanced Managed and £300m Equity and Bond portfolios, which both have seven funds in the Wealth 50 list in their top 10 holdings.
The same funds also tend to crop up several times across the MM range. For example, Artemis Income is included in four of the MM funds’ top holdings, with the £2.8bn Income and Growth fund having as much as 17.3 per cent exposure.
There are a number of reasons why this should be a cause for concern.
First, the risk is that a lot of client money could be exposed to the same fund managers. If any of these funds run into problems (as we saw with Woodford), that’s potentially hundreds of millions of pounds of client money that ends up suffering the same fate.
Hargreaves may continually analyse the recommended funds, but the fact that it kept Woodford on its Wealth 50 for so long after he breached regulation doesn’t inspire much confidence.
Second, the sheer volume of money invested via Hargreaves means that, whenever the company adds or removes funds from its Wealth 50, it’s likely to have a big impact. Consider that, collectively, Hargreaves clients accounted for £1.6bn of the £3.7bn Woodford Equity Income fund in June.
In a worst case scenario, dropping a fund from the list could lead to a mass exodus of money, potentially leaving the manager with no option but to sell assets at discounted prices to meet redemption requests. This in turn could be detrimental to the MM portfolios that hold the same fund.
Given that the same team select the funds for both the Wealth 50 and the MM range, the final concern is whether there is a conflict – that is, those overseeing the MM funds may not be making decisions that are in the best interest of their clients because they want to avoid a knock-on effect on the best buy list, or vice versa.
When City A.M. put this to Hargreaves, head of investment analysis Emma Wall said: “There has always and will always be an overlap between the Wealth 50 and MM funds – it’s the same analysis but expressed in two different ways.”
When asked if this strategy exposed them to a high level of concentration risk, Wall pointed to a paper published by the Financial Conduct Authority back in 2017, which found that – while best buy lists had a substantial impact on fund flows – on average, they drove investors into superior investments, which in turn produced better results.
A letter from Hargreaves chief executive Chris Hill to former chair of the Treasury Committee Nicky Morgan had said that there is “no commercial conflict of interest between the best buy list/model portfolio provider and their clients”.
Many industry figures have argued that it makes sense for the same research processes to be used for both the Wealth 50 and MM funds.
Mike Barrett from The Lang Cat says he would be more concerned if the firm had two in-house views of what represents the best funds. However, Barrett also warns that a consequence is that you could find that customers’ assets are concentrated into a relatively small number of funds.
“This is especially the case for Hargreaves in its position of market leader,” he warns. “I would expect it will be looking to strengthen the internal governance around its fund selection process as the lessons from the Woodford case are learnt.”
Anthony Morrow, co-founder of digital advice service OpenMoney, also defended the overlap of funds, saying it’s to be expected. However, he also warned that, generally speaking, having too much invested in any single investment is always a risk if things don’t go according to plan.
Much of Woodford’s popularity was due to Hargreaves promoting his funds – and while the Wealth 50 buy list has worked well (partly as a marketing tool for fund managers), it has been a victim of its own success, largely because the scale of the company increases the risk.
Non-advised platforms like Hargreaves don’t restrict investors’ individual exposure to one fund. However, unlike Hargreaves, some platforms – like AJ Bell and Interactive Investor – will monitor their best buy lists to ensure that, collectively, their clients are not overly exposed to any single fund.
From a general investment platform perspective, Ryan Hughes, head of active portfolios at AJ Bell, said that it’s “almost inevitable” that there will be a crossover between the MM funds and best buy list. But Hughes admits that the downside to this is that it could increase the concentration risk.
“It’s therefore important to monitor how much exposure you have to a fund at an overall firm level to understand if you are overly exposed to a manager or strategy, particularly if something goes wrong or that manager leaves, creating a significant outflow.”
The investment expert also pointed to the shrinking of buy lists across the industry in recent years, which has directed assets to fewer funds than we have seen historically.
“Of course, this is making it harder for new funds to raise assets and grow, hence stifling competition in the market. At the same time, we are seeing consolidation in the wealth manager market, which is again concentrating assets into fewer and fewer funds.”