Wrap funds (also referred to as model portfolios) fall into the category of typical financial jargon that financial advisers use, but comes across as Latin to the everyday investor. This article explains how wrap funds work and why many financial advisers are offering them to their clients.
Basics of a wrap fund
A wrap fund is not actually a fund, but is more accurately described as a model used to align investor portfolios so that all investor portfolios look exactly like the model. The investor holds the underlying investments directly. Wrap funds usually consist of combinations of unit trusts structured around different objectives, and can vary depending on the needs of a group of investors (conservative to aggressive risk profiled).
Most financial advisers offer three wrap fund solutions for their client:
- Low equity - suited to investors with a cautious risk profile.
- Medium equity - suited to investors with a moderate risk profile.
- High equity - suited to moderate aggressive investors seeking higher risk with the generally associated higher return.
If the manager makes a switch in the wrap fund model, the investor automatically receives the same adjustment. The investor’s statement will reflect the underlying holdings instead of the wrap fund model. Wrap funds require a great deal of back-end administration and are only offered on LISPs (investment platforms) like Glacier, Investec and Momentum. Portfolio managers usually partner up with these LISPs and manage the wrap funds while leaving the admin to the platforms.
Pros and cons
The biggest benefit of using wrap funds is the ease of implementing investment decisions across a range of client portfolios. Switching all client portfolios from one fund into another requires just one trade instruction, instead of a switch form for every individual client. This process of automatic rebalancing bears no transaction costs and ensures that all clients are treated in the exact same manner, which is a regulatory requirement under TCF (treat clients fairly). It also reduces the administrative burden, thereby freeing up time for the adviser to focus on service delivery.
Wrap funds allow financial advisers to offer a unique solution exclusively to their clients. The management of wrap funds must be done by a category 2 FSP like Sharenet Investments (that carries the necessary FSB licence to manage assets on behalf of clients). Having a resourceful and reputable asset manager overseeing the wrap fund can reduce the time spent by financial advisers on researching funds for client portfolios. Wraps can be custom branded, and the fees are flexible with management fees usually capped at 0.50%. Sharenet Investments offers wrap funds at very competitive fees from as low as 0.10%.
The arguments against the use of wrap funds are often client specific. The trading activity in a wrap fund could trigger capital gains tax for certain investors, but wrap funds generally do not see significant portfolio turnover, and the tax does not affect retirement funds. This is the main drawback relative to fund of funds (FoF) unit trusts, which trigger no tax on the buying and selling of underlying funds. The performance of wrap funds is also not readily available in the media whereas the return of unit trusts can be monitored daily. This has become less of a problem in recent years as platforms give investors online access to view their portfolios daily and hence monitor the wrap model portfolio’s return.
Setting up and implementing wrap funds is very easy, and combined with their benefits, has led to many wealth firms (large and small) opting to use wraps for their clients. Financial advisers who partner up with an asset manager who offers wraps can benefit from reduced admin and research time. The asset manager may also generate marketing material for advisers to help them report professionally to clients. Our clients receive all these and additional benefits that can be viewed on our website.
Quantitative Investment Analyst
Ian Stiglingh is a full time quantitative analyst, responsible for research of equities across all industries. Ian completed his degree in Mathematical Science in 2013 and his Honours degree in Financial Risk Management in 2014, both at the University of Stellenbosch. During his studies, Ian worked as an intern at Old Mutual Actuaries & Consultants as well as J.P. Morgan in Johannesburg, and is currently a CFA candidate