All you wanted to know about investment management but were afraid to ask: external versus internal

By Kevin Mitchelson

After an unforgivably long intermission, I return to the next topic in the list below: external versus internal.

• Absolute return or benchmarking
• Active versus passive
• Intermission
• External versus internal
• Single sector or multi sector
• Timing versus selection
• Top down or bottom up

And, no this isn't about different sorts of medication, but about who actually manages the assets in a fund.

In the intermission which looked at who did what to who in KiwiSaver schemes, I drew a distinction between "investment managers" and "fund managers". In a nutshell, an investment manager decides things like what sort of assets the fund will invest your hard earned in, what the mix of assets will be and how they might change over time.  Call it investment strategy. Fund managers look after the day to day management, doing the research and analysis  and the buying and selling.  Call it tactics.

Of course that is an oversimplification.  Let's flesh it out by looking at some KiwiSaver examples.

Some managers do everything like Brook Asset Management, Fisher Funds and Milford Asset Management.

At the other end of the spectrum are what you might call "managers of managers" and there are quite a few of them: Aon, Credit Union, Kiwibank (apart from its cash fund), Law Retirement, Medical Assurance (who actually use Mercer), Mercer itself, NZ Funds, Staples Rodway and Superlife.

And in the middle you have those who are fund managers for some of their funds in a fund and farm the others out to external managers. For example AMP has KiwiSaver funds managed by Tyndall, OnePath and Tower.

But wait there's more!

You also have investment managers who will fund manage some of the assets in a fund and have external fund managers take care of the rest.

To see who manages a particular fund, go to this page and choose the relevant scheme. Where it says multiple, it means there are a number of fund managers for that particular fund which you can (sometimes) find in the investment statement.

I tend to split those investment managers that use external fund managers into 2 types: those who are using their brand and those who are seeking a particular expertise that they don't have inhouse.

In the former I would put Credit Union Law Retirement, Kiwibank, Medical Assurance and Staples Rodway.  They are using their brand to get the money in the door or appeal to a particular market (e.g. doctors). The latter use external fund managers to access skills like investment in emerging markets, alternative assets and offshore markets.

Now it makes a lot of sense to get someone else who has a particular skill to manage those sort of assets and it gives KiwiSavers access to more choice. And there is a place for investment "managers of managers" like Mercers who have huge knowledge about worldwide fund managers.

However, I have a number of grouches.

Firstly, not all KiwiSaver investment statements tell you who is doing the actual fund management.  Even if they say it's them, in a fund where there are a number of different types of asset, I harbour suspicions that they might be using external managers.  In essence they are saying, "trust us".  fair enough, but it would be nice to know.

Secondly, it would be nice to have a bit more detail about who makes what decisions in the management of the fund.

And lastly, and you guessed it, is fees!

The more layers of management there are, the more layers of fees there are - the Heath Robinson darwing at the top tries to have some relevance.

Nobody does nothing for free in the big bad world of investment management.  And fees gnaw away at returns.

No KiwiSaver investment statement says what it pays external managers.  No, that is "commercially sensitive".  Some like AMP do say things like :

The investment management fees payable to the managers of the underlying funds in which Scheme assets (excluding Cash Fund and AMP Default Fund assets placed in bank deposits) are invested are met from the annual management fees outlined above.

(The barrack room lawyer in me could be picky and say that doesn't specifically cover external managers but I'll leave it there).

The real point is being able to judge whether you are getting value for money. Fine, use external managers but tell me whether their fees are coming out of your pocket or mine and if you don't like letting your competitors know how much you are paying, at least tell me the total cost of without telling me the split.

Hopefully this might be addressed in the current review of KiwiSaver regulation (see here), but the cynic in me certainly won't be holding his breath.

So look for who is actually doing the fund management in the investment statement and if it's not there ask.  And if you are feeling cheeky, ask how any external mangers are being paid. You can bet your bottom dollar your average investment adviser will not have a clue.

Next up: single sector or multi sector.