Focus on Funds: What now for ‘best buy’ lists post-Woodford?

 

Coming from a site that seeks to educate and inform personal investors, it may sound odd for DIY Investor to highlight the potential danger of information overload.

 

But, given the sheer volume of information available, there is a need for filters, and this we do by sourcing content from expert industry figures, commentators and participants.

In DIY Investor you will see content from fund managers sharing their view of the world, their goals and their investment strategy, to allow you to make informed decisions; by the same token we have real investors, facing challenges just like you and investing their own money – real life experience and advocacy

In a similar vein, as online investing grew massively over the last 20 years, many of the top DIY investing platforms adopted ‘best buy’ lists to help personal investors navigate the massive amount of choice that exists, particularly in investment funds .

However, the fallout from Woodford’s Equity Income Fund has concentrated more attention on these lists – in particular how they are constructed, and how people use them; inspiration is fine, faux advice should not be.

The fact that Woodford’s fund remained in Hargreaves Lansdown’s hugely influential ‘Wealth 50’ list, until the day it was suspended prompted many to question the relationships between brokers and fund managers — and whether best buy lists will be curbed, or the method of their construction made more transparent.

‘prompted many to question the relationships between brokers and fund managers — and whether best buy lists will be curbed’

A recent survey by consumer finance site Boring Money found that trust in best buy lists had been ‘eroded as a result of Woodford’ but that despite their doubts, investors have come to rely on them to help them make decisions.

Hargreaves Lansdown was one of the first DIY investment platforms, launching its ‘Wealth 150’ list in 2003; when in 2012 RDR forced the switch from commission-based advice fees to upfront fees, many ditched their adviser and turned to buy lists as a solution to the ‘advice gap’ created by unaffordable fees.

Although they do not constitute financial advice or guidance, buy lists represented a solution, and being featured on a list carries huge weight with the FCA estimating 17% of non-advised platform customers use one.

When a fund is included in a list, it attracts an average of £5.9m in new investor money every year — possibly 1% of the fund’s total AUM;  one consequence is that more and more investors buy the same managers, concentrating their cash thereby increasing the chances of ‘a Woodford’.

‘When a fund is included in a list, it attracts an average of £5.9m in new investor money every year’

Despite their strong influence, questions are being asked about the lack of rules governing the construction of best buy lists; seemingly anyone can construct a list of funds that have performed well, but it is for investors to decide if they trust the list – ‘past performance is no guarantee…’ etc.

Woodford’s fund appeared on many lists, but the fact that Hargreaves stuck with it despite prolonged underperformance and concerns over liquidity has angered investors whose cash is now stuck.

FCA stopped short of imposing rules on buy lists earlier this year, but it said it expected lists to be constructed on ‘an impartial basis’; however, it is clear that to many investors the list represents the endorsement of a brand they trust, sitting somewhere between marketing and, whisper it, advice.

Then chair of the Treasury select committee, MP Nicky Morgan said: ‘If a recommended fund list is no longer purely about performance and is repeatedly pushed on to customers, it begins to look and feel like advertising or financial advice, [in which case] it should be disclosed for what it is and regulated accordingly.’

‘the list represents the endorsement of a brand they trust, sitting somewhere between marketing and, whisper it, advice’

No commission is paid when a platform includes a fund in its best buy list but because many charge fixed fees for trading other assets such as ETFs and investment trusts, it could prompt bias in the promotion of funds; of the five largest DIY platforms in the UK, only Interactive Investor’s Super 60 list covers the whole of the market.

Ian Sayers, chief executive for the Association of Investment Companies said: ‘If a best buy list excludes investment trusts, it is hard to claim that the list provides the best options to meet consumers’ long-term investment needs,’; Hargreaves countered, saying that recommending trusts could result in a surge of investment , causing a spike in the share price.

Another potential conflict is the fee discounts negotiated with fund managers to reduce investment charges for investors — potentially allowing fund managers to ‘buy’ their way on to recommended lists.

It seems that Woodford’s fund kept its spot in the Wealth 50 following a review in January 2019 in exchange for an extra 10bps discount; Terry Smith’ s top-performing fund has never featured on the list as he refuses to play ball with a practice he sees as putting the interests of the platform ahead of the investor.

‘refuses to play ball with a practice he sees as putting the interests of the platform ahead of the investor’

Hargreaves maintains that its platform fee model aligns its interests with those of its customers – if they select a fund that outperforms both the investor and platform benefit; it claims that its customers saved £61m in fees last year because of the discounts it negotiated.

Similarly, AJ Bell, Fidelity and Barclays Smart Investor all seek to negotiate reductions with fund managers whose products they recommend, but maintain that their selection processes were investment-led.

Policymakers have concerns that some platforms are not upfront about which criteria they prioritise in selecting funds; Hargreaves Lansdown told the Treasury select committee in June that its Wealth 50 ‘combines two elements: what we believe are the best funds, at the best prices’.

However, Ms Morgan countered, saying that investors using the list would have assumed that it represented ‘the top 50 funds that Hargreaves thought would perform well, not 50 funds that might have lower negotiated fund fees’.

 

 Do recommended lists add value?

 

In 2017, the FCA concluded that funds on best buy lists exhibited ‘significantly better past performance’ than non-recommended funds; critics say that buy lists’ lack of accountability has allowed poor performance to go unnoticed.

FT Money research conducted by Fundscape into returns generated by UK and European Equity funds featured on five buy lists – Fidelity, Charles Stanley, Chelsea Financial, Bestinvest and Fidelity – over three years showed platforms have a patchy record in tipping winning funds.

Only Fidelity and Chelsea’s UK equity recommendations on average beat equivalent tracker funds over the period, net of fees; all apart from Fidelity, included Woodford.

European funds also fell flat, with all selections underperforming the Vanguard FTSE developed Europe ex UK equity index fund;  Hargreaves’ Europe ex-UK fund picks delivered 10.94% over three years, lagging the 12.26% delivered by Vanguard’s tracker.

Hargreaves says funds on average outperformed benchmark and sector average by 5.8% and 11.8% respectively while recommended; Charles Stanley blamed the poor performance of its buy list on the presence of several value-focused funds, which have been out of favour in recent years, adding that the range of styles and risk appetites featured in the list are likely to result in ‘a wide range of outcomes’.

‘not to blithely follow the recommended funds, but to actively monitor and manage your portfolio’

A clear message to investors is not to blithely follow the recommended funds, but to actively monitor and manage your portfolio; just as fund managers won’t always get it right neither it seems will those that construct best buy lists.

Daniel Godfrey, of the Investment Association said: ‘The role of the best-buy list is about diversifying and giving people a list of products where the majority will do a good job,’ adding that while it is unreasonable for investors to expect lists that consistently deliver winning picks, they are right to expect platforms to implement governance to ensure wrong calls are the result of human error rather than commercial conflicts.

Following the Woodford suspension, Mr Godfrey says the onus is on platforms to explain their selection process and governance checks to investors. ‘After what has happened it would be smart for platforms to think about their governance and improve this if they can. If this doesn’t happen, it may be something the regulator needs to look at.’ FCA said the watchdog would look again at whether brokers were compiling buy lists on an impartial basis.

FCA acknowledged the useful role buy lists play, but it is likely to apply greater scrutiny to selection process and how discounts are structured.

Fund concentration risk is another factor, because as well as featuring on the Wealth 50, Woodford Equity Income fund also featured prominently in the broker’s multi-manager funds; removing the fund from the list would have had a potentially very damaging effect on its own funds.

The sheer scale of the £19bn Fundsmith Equity fund prompted broker Charles Stanley to remove it from its list in July, noting that the manager had ‘barely put a foot wrong since launch’.

 

Looking ahead

 

Hargreaves has promised to make changes to the Wealth 50, acknowledging ‘learnings and improvements’ post-Woodford; others say a more fundamental rethink of buy lists is needed.

Platforms say their lists are intended as a guide for investors to use alongside their own research, but according to Boring Money, as many as one in four investors rely solely on platforms’ recommendations in making investment decisions and trust buy lists implicitly; founder Holly Mackay believes it is ‘inevitable’ that platforms will outsource fund research to independent providers to eliminate conflicts of interest.

This is the approach taken by DIY broker Selftrade which outsources its Mutual Funds Select List to Square Mile Research, and is now looking to increase its presence in the actively managed space.

‘it is ‘inevitable’ that platforms will outsource fund research to independent providers’

Head of Relationship Management at EQ Invest Richard Latter told DIY Investor: ‘The fact is there is such a bewildering amount of choice that it is very difficult for the time poor investor to put in the hard yards required to make informed investment decisions.

‘We initially commissioned Square Mile to supply analysis and research on around a dozen funds, divided between Cautious, Balanced and Adventurous to see how our customers would respond.’

The result has been positive and Selftrade is now considering expanding its universe of funds: ‘The feedback we received was overwhelmingly positive, and people really bought into the importance of delivering truly independent research in the wake of the Woodford debacle,’ said Mr Latter.

To help get the message across, Selftrade commissioned a publication dedicated to actively managed funds: ‘We have always believed firmly in the importance of delivering education and good information to our clients and Focus on Funds is an important part of that strategy,’ he said.

And the importance of independent research has apparently hit the spot: ‘this initiative with Square Mile and Focus on Funds has clearly struck a chord and is being seen as a key business driver,’ said Mr Latter.

Customers may not have previously been aware of the machinations of the lists, but will now be fully apprised of how they work in the future and their potential compromises, shortfalls and benefits.

 

Clearly the Woodford saga highlighted some structural flaws if not sharp practice in the area of best buy lists, and now that the genie is out of the bottle, we can expect fundamental changes moving forward; possibly greater transparency in the short term and more ‘off-shoring’ down the line.

That can only be a good thing for DIY investors that still find themselves without access to affordable or simplified advice, but determined to build their long term wealth.