Financial advisers increasingly face a choice between managed (or model) portfolio services (MPS) and multi-asset funds (MAFs) for client investments. In this article, Robin Powell explores this debate, highlighting recent data and trends. While MPS assets have surged, MAFs remain popular for their versatility. Powell makes a compelling case for low-cost, passively managed options like Sparrows SCore MPS, which combines MAFs’ diversification with the cost efficiency and performance potential of evidence-based rules-driven strategies.

There’s been quite a debate in the financial advice trade press in recent months about the rival merits of managed (or model) portfolio service (MPS) investment solutions and multi-asset funds (MAFs).

The trend in recent years has been away from multi-asset funds, towards MPS. A report published in June by the consultancy NextWealth showed that  £123bn was held in discretionary MPS portfolios at the end of March, up from £71bn in 2021. Assets in multi-asset funds stood at £174bn, down from £179bn at the end of March 2021.

A recent report by Aegon, however, shows that multi-asset funds continue to be the option of choice for most financial advisers. Aegon found that 90 percent of advisers questioned are using them for both accumulation and decumulation. Another interesting finding from the NextWealth study was that almost 80 percent of advisers surveyed used both MPS and MAFs.

Recent analysis by Citywire

But which of these two solutions is likely to give investors the highest risk-adjusted returns in the long run? Citywire recently examined the returns of more than 1,000 multi-asset MPS portfolios against equivalent funds. Over both three and five years to the end of June 2024, MPS portfolios on average outperformed funds in four out of five of Morningstar’s UK multi-asset sectors.

The advantage of MPS was most pronounced over a five-year period, with MPS solutions outperforming funds by an average of 2.4 percentage points across the five sectors. In the GBP Allocation 40-60% Equity sector, where the gap was the largest, MPS portfolios achieved an average return of 19.4%, compared to 15.4% from funds, according to Citywire’s calculations.

Interestingly, Citywire’s analysis also showed large differences in performance between MPS portfolios and multi-asset funds run by the same providers. For example, Quilter’s WealthSelect Active Managed 9 portfolio delivered 46.9% over five years — nearly double the 23.6% from its Cirilium Adventurous fund. The explanation, apparently, is that the two have completely different portfolio management teams. Where a fund provider’s MPS and MAF offerings are run by the same managers — in the case of Charles Stanley, for example — the returns delivered were broadly similar.

Are we missing the point?

But how informative are comparative studies such as these? Surely both MPS solutions and multi-asset funds have the potential to provide excellent, and, for that matter, dreadful, investment outcomes? What really makes the difference is the type of investment strategy. For example, is it a low-cost, long-term, rules-based strategy? Or is the strategy dictated by fund managers making active decisions and charging higher fees?

An example of a sensible MAF option is a Vanguard LifeStrategy fund, with a simple asset split between equities and bonds depending on the client’s risk profile. If you hold a LifeStrategy fund for the long run, you will never shoot the lights out, but you will outperform the great majority of investors on a cost-and-risk-adjusted basis.

However, when financial professionals talk about multi-asset funds, they are usually referring to actively managed funds where the portfolio manager makes strategic decisions to buy and sell assets across multiple asset classes, and not just stocks and bonds, but also, for example, commodities, real estate and cash.

Tactical allocation doesn’t work

Investors, and indeed many financial advisers, are easily seduced by the notion of so-called tactical asset allocation (TAA), and fund houses are very clever at promoting the idea of “nimble” fund managers having the flexibility to “go anywhere” and dip in and out of different assets depending on the latest information. But there is overwhelming evidence to show that TAA simply doesn’t work. Sure, some funds are bound to make the “right” calls on occasions, but consistently getting it right over meaningful time periods is extremely challenging.

The limitations of tactical asset allocation were highlighted in a study by Fundhouse published in May this year. Researchers analysed 160 multi-asset strategies in the Investment Association’s Mixed Investments 40-85% Shares sector that had at least a five-year track record, many of which were run on a 60/40 basis.

Fundhouse compared the sample to two 60/40 benchmarks, rebalanced twice a year, one with a UK home bias and one without. For the 40% bond allocation, they used a global aggregate bond hedged to a sterling index. For the equity element with a UK home bias, they used a 15% UK, 45% global ex-UK blend, and for the equity element without a UK home bias, they used a standard global equity index.

What the researchers found was that, over ten years to the end of March 2024, fewer than 15% of the 160 funds they looked at outperformed the fully global benchmark, and fewer than 20% outperformed the UK-biased benchmark. The findings were broadly in line with those of a similar study Fundhouse conducted three years earlier.

Why does TAA usually fail?

Both of these Fundhouse studies have shown that passive strategies work best, and if you’re going to own a multi-asset fund, you’re almost certainly better off with a passively managed one. But why should that be? Why is tactical asset allocation so hit and miss?

The Fundhouse researchers suggest two possible explanations. “The first,” say the researchers, “is that we are wired to have a brake pedal that is bigger than our accelerator — believing that a rustle in the grass was a predator, when it was almost certainly the wind, saved our life. The instinct to err on the side of caution may cause fund managers to reduce risk too soon and add it back too late.

“The second relates to the approach… Asset allocation in most multi-asset strategies is heavily influenced by macro insights and forecasts. Our research suggests that the odds of getting these forecasts consistently right are very low.”

A big misconception about MPS

So let’s say you’re an adviser and these findings Fundhouse have convinced you that actively managed multi-asset funds are a bad idea. For whatever reason, though, you’re reluctant to recommend a simple passive 60:40 fund to your clients. Is the answer simply to use an outsourced MPS instead? Well, not necessarily. Why? Because, as with MAFs, when most financial professionals talk about MPS, they’re usually referring to old-style discretionary fund management — actively managed and expensive. What advisers should be using instead are one of the newer MPS solutions, like Sparrows Capital’s SCore MPS, which are essentially passive — or at least rules-based — and low-cost.

Another finding of the Aegon research referred to earlier is that many advisers wrongly assume that all MPS solutions are relatively expensive. 80 percent of the advisers surveyed by Aegon considered MPS to be a more costly investment approach than multi-asset funds. Yes, some MPS solutions can be eye-wateringly expensive, but Sparrows SCore MPS, for example, is the very opposite, costing just 21 points a year, with a cap of £20 per client per month. This includes a DFM fee 0.10%, a portfolio OCF 0.09% and transaction costs of 0.02%. In other words, Sparrows Capital’s SCore MPS is a model portfolio service that is about five or six times cheaper than a typical actively managed multi-asset fund.

Lower costs mean higher returns

This huge cost advantage of passively managed MPS solutions inevitably translates into superior performance — even over shorter time periods. This was recently illustrated by the financial data provider Defaqto, which compared the performance of model portfolios categorised as “adventurous” over the three-year period to the end of May 2024.

Remarkably, nine out of the top ten portfolios were passively managed. Sparrows Capital’s SCore Market Equity 100 portfolio ranked third out of 261 funds.

The three-year cumulative return of SCore Market Equity 100 was 27.22 percent, which was 17.03 percent better than the overall average of 10.19 percent and hugely superior to the returns produced by the worst performers. During the three-year cumulative period in question, 51 portfolios failed to achieve a total return of two per cent. Of those 51 portfolios, 27 even contrived to record an overall loss!

Takeaways for advice firms

What are the key takeaways, then, for financial advice firms that are trying to decide on how best to invest their clients’ money?

The most important one is to ensure they ask the right questions. What matters most is not whether you go with MPS and MAFs, but how the assets are managed and how much your clients will pay.

The fundamental design fault with most multi-asset funds, and indeed with most MPS solutions too, is that they are actively managed. In the long run, very few active managers will outperform the market through stock selection, market timing or tactical asset allocation with any consistency. What’s more, identifying those managers in advance is a very tall order.

The way to give your clients the best possible chance of a successful investment outcome is to diversify across different asset classes and, ideally, across risk factors such as small size, value and profitability as well. You should, of course, invest for the long term, maintain a static asset allocation and keep costs, including unnecessary trading costs, to a minimum.

Without question, the best way, in my view, to do that, is to use a low-cost, evidence-based investment solution like Sparrows Capital’s SCore MPS.

ROBIN POWELL is a freelance journalist and editorial consultant to Sparrows Capital.