CAPE TOWN – In the ongoing debate around the Third Circle MET Target Return Fund that lost 66% in just two days last December, one of the issues that has been focussed on is the white labelling of unit trusts. This is the practice of a management company (manco), such as Metropolitan Collective Investments (MetCI), allowing smaller managers to run funds on its licence.
In a white label agreement, the manco effectively outsources the actual portfolio management to a third party. It however remains ultimately responsible for the fund.
The practice of white labelling is still relatively new in South Africa, and only a handful of management companies do it. For some, like Prescient or Sanlam, it is a small part of their business, but for others such at MetCI it is the bulk of what they do.
The primary purpose of white labelling is to give smaller managers a means to compete in an industry that has relatively high barriers to entry. Registering and running a manco is both time consuming and extremely expensive. Being able to use another company’s licence therefore gives these managers the chance to focus on portfolio management, and leave all of the back office requirements to the manco.
There is also no question that some boutique managers have taken advantage of this to run some incredibly successful funds. The likes of 36ONE, Autus, 27Four, Mazi and Anchor are all very highly regarded and extremely successful.
However, there is also little question that the majority of white-labelled funds are, at best, ordinary. There has been an explosion of small funds in the country, many of them funds of funds, that offer no real value proposition.
This is the first issue that most industry insiders highlight when discussing this question. It has been relatively easy to get a category II discretionary fund manager’s licence and start up a white-labelled fund of funds.
A lot of financial advisory firms, and even individuals, have done this. Undoubtedly a few of them have developed strong processes and well-run funds, but most add questionable value.
This has been a major criticism of white labelling – that it allows advisers to charge an asset management fee on top of their advice fee when they put clients into their own funds. The only benefit to the client in this arrangement is that within a unit trust structure the adviser can move in and out of funds without the investors paying capital gains tax, but it’s doubtful whether that justifies the ultimate cost.
The second big criticism of white labelling is that for some mancos it has now become a business model. In other words, they have very few or no funds of their own, and concentrate primarily on signing up other managers.
Many people in the industry see this is a highly problematic conflict of interest. If your business model is white labelling, you are incentivised to white label as many funds as possible, as that is how you grow the value of your business.
The first issue here is that if your focus is to sign up more and more funds, your standards may well be compromised. The counter argument from these mancos is that if their business is white labelling they will be more careful about who they sign up because they have both their business and their already-wide client base to protect. However, the fact remains that there is not an endless source of good asset managers out there looking to set up their own funds.
The second issue makes the first even more problematic. Because the more funds that a manco has, the more challenging it is to run proper risk management, portfolio surveillance, and compliance monitoring across all of them.
It is unlikely that a manco can, in real time, monitor trades and asset allocation decisions made at dozens of remote locations. The fact is that in big asset managers, the distance between the head of compliance, the dealing desk and the portfolio management is probably never more than one floor. But in a manco running scores of white labelled funds, it could be the distance from one end of the country to the other.
This is a serious, and critical challenge. It is also brought into focus by the losses sustained in the Third Circle fund.
Did MetCI have sophisticated enough systems in place to monitor what was happening in this fund, particularly in terms of the risks its was taking? Were its processes robust enough? And could it engage quickly and effectively enough with the portfolio manager?
Those are questions that still need to be independently answered and what is discovered may have important repercussions for white labelling in South Africa.
There is no doubt that giving smaller asset managers a way to compete against the established players in the unit trust industry is important. The market would be much poorer off without some of the brilliant boutiques that have used white labelling to launch their own funds.
But asset management is not just a business, it’s a responsibility. When other people’s life savings are involved, there is a duty to be prudent.
That is why more introspection is needed by both the industry and the regulator on the question of whether the barriers to entry haven’t now been lowered too far. There have to be standards in this industry, and it’s questionable whether those are currently set high enough.
And if white labelling is to be allowed, the mancos doing it have to be placed under even tighter scrutiny. Their systems actually have to be better – much better – than those run by the asset managers with their own mancos. Anything else is putting investors at risk, and that should be unacceptable.