*This article is produced in partnership with Allan Gray

With the recent rise in the popularity of managed accounts, one would be forgiven for thinking that the diversified managed fund is a product of yesteryear. We, however, believe the role of diversified managed funds is more pressing than ever before.

In this recent article, we looked at how we believe there is a role for diversified funds in almost any multi-asset portfolio and could be held alongside or within a managed account. As discussed, this approach will not only reduce the risk of having all clients in a single investment approach, it could potentially lead to better client outcomes as well. This is because a diversified managed fund has a broader toolset available with which to manage risk and seek outperformance.

What are some of the ideal elements of a diversified managed fund that could benefit an existing managed account?

We believe there are five key elements essential to managing a successful diversified fund:

  • Flexibility, both within and across assets classes
  • Built from the bottom up, on a security-by-security basis
  • Allow the use of derivatives to manage risk
  • Active currency management, to reduce potential losses from overvalued currencies and to seek alpha from undervalued currencies
  • True alignment of interest between the portfolio manager and the end client

Let’s get into the detail:

  1. Flexibility to drive returns

If you believe an active manager has the skill to outperform, you need to allow that manager considerable flexibility and opportunities to make active investment decisions. In practice, however, diversified portfolios are often quite limited in terms of the flexibility given to decision making. Managers may also be limited in the types of assets they are allowed to allocate capital to, or restricted in terms of geographic allocations.

This inflexibility prevents the manager from taking advantage of the relative value on offer across asset classes. A traditional, rigid 60/40 split between growth and income assets leaves little room for taking advantage of opportunities when they arise, nor the capacity to increase exposure to underperforming assets with the potential for future outperformance. For example, when equity markets are high and valuations are stretched, managers should seek better value elsewhere if it is available. A rigid 60/40 split prevents this. We believe flexibility to invest across different asset classes, and at a security level within those asset classes, is key to maximising investor returns.

  1. Building a portfolio from the bottom up with individual securities

There are two primary ways to construct a diversified portfolio – own securities directly, or use a building block approach using managed funds and ETFs. Most diversified portfolios take the latter approach and outsource equity and bond research to different companies. Even if the portfolios are comprised of different investment funds offered by a single investment manager, it is likely that equity and bond teams are working separately and comprised of different people. This makes it difficult to assess the relative attractiveness of different asset classes or funds when deciding portfolio weightings. If the manager is creating a multi-asset fund from internal funds, tension can be created when changing allocations, as the manager must take money from one part of the business and give it to another. Internal political considerations can cause friction in the movement of capital.