There has been some considerable debate between. Why Individual Managed

Why individual managed

accounTs are righT,

righT noW

Stuart Holdsworth

T

here has been some considerable debate between the use of managed accounts over managed funds in the last few years, much of which has centered on whether managed accounts are a better structure than managed funds. This debate appears to largely conclude that as an investment vehicle holding underlying assets that are reasonably liquid and tradable, managed accounts are the clear winner as they can provide transparency of investments, portability, liquidity and also often the ability to tailor outcomes to an investor’s specific rules, preferences or constraints.

Whilst such benefits of managed account portfolios are helping many investment advisory practices offer a superior structure to their clients, there are also a number of additional benefits that such clients are realizing if the management of their investments is in an Individually Managed Account (IMA – estimated market size $50–$80Bn in Australia) as opposed to a Separately Managed Account (SMA – estimated market size $2-4Bn in Australia).

The key difference between an IMA and SMA is that:

•

An IMA is generally offered and operated to the client by the person that they have a relationship with, and the IMA may consider some of the clients personal circumstances; and

•

an SMA which is typically offered by a ‘product’ manufacturer

which produces a product according to a Product Disclosure Statement (PDS) that is then promoted by the client relationship manager (advisor) to the client.

Whilst there are some great SMA products out there in the market,

the subtle difference between SMA products and IMA services may have considerable implications, namely:

•

That with an IMA, the client often can talk directly to the person who is managing their investments and making decisions for them. Research of clients of private wealth managers has indicated that such clients like to know who the person is managing the investments, and seek communications at a level and frequency that suits the client, often beyond a quarterly paper report.

•

That with an IMA, the resulting investment decisions are often

tailored to the client’s specific situation rather than being solely driven by the specific desires of a product manufacturer, who perhaps is more focused on his or her relative performance to their peers rather than the end investment result of the investing clients. As Roger Montgomery from Clime Asset Management says ‘IMA’s offer transparency, access to the manager and for fund manager’s willing, accountability. Most importantly IMA’s ensure that tax consequences relate only to the activity of the individual. No longer do you suffer financially from the buying and selling of others.’

In times where many investors are seeking additional support with their investments, helping them with an understanding of the market and the specific value and decisions associated with their portfolio are perhaps more important than ever. If the interest in Financial Simplicity for IMA technologies over the recent months is anything to go by also, perhaps these key points are now becoming important enough to prompt advisers and dealer groups to strongly consider an alternative way of delivering investment value, with a move perhaps from product distribution (whether managed funds or SMAs) to a tailored client service delivery model.

stuart holdsworth, financial simplicity

Stuart Holdsworth is chief executive officer of Financial Simplicity, an international wealth management technology company that specialises in facilitating mass tailored portfolio management operations that power

managed accounts programs (IMA, SMA and UMA) at some of the world’s leading financial organisations.

53 www.fssuper.com.au Volume 04 Number 01 | 2012 The quote We are seeing an increasing number of advisers that whilst offering valuable advice, are starting to deal with the reality that investors can access managed fund products cheaply, and often with fee rebates, from various discount on-line providers over the Internet. Jon Reilly from Vivid Financial says ‘Sophisticated

clients demand the transparency and flexibility that managed accounts can provide. In the exceptionally volatile times that we have recently endured, the ability to have an open line of communication between the investor and the people making the buy and sell decisions has been invaluable. Investors are realistic, and they don’t expect us to time every trade perfectly. When they know and understand why we own a company in our portfolios, then the short term price movements becomes less important’.

Contemporaneously, a key business issue that advisory groups are starting to consider is the sustainability or attractiveness of the current sharing of revenues and fees on the current product/platform/dealer/adviser product distribution supply chain. This consideration is further fuelled particularly in an environment of down markets, fee pressures and possible regulatory change from examination of conflicts of interest, not to mention increasing consumer backlash. In some circles the issue of practice sustainability is considered in the context that a practice that relies largely on commissions may be at substantially more risk than one that has a good mix with fee for service and offering direct investments portfolio services. These are interesting times perhaps suggesting an evolutionary change in the advisory practice business model.

To address these issues of sustainability and attractiveness, let’s look at the supply chain from some different perspectives to better understand why IMAs are quite an attractive option for many right now.

adviser perspective

We are seeing an increasing number of advisers that whilst offering valuable advice, are starting to deal with the reality that investors that can access managed fund products cheaply, and often with fee rebates, from various discount on-line providers over the Internet. Within such an information rich Internet enabled world and direct access to products over the Internet, the role of advisers in any industry is becoming not just about access to information or product (because everyone can get this now) but more about putting information in context of their clients. In the investments industry this means two things:

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that advisers are needing to become exactly that for the breadth of their services, providing each piece of advice in context of each and every client

•

that from an investments offering perspective, advisers are in the best position to manage, assist, or perhaps just ‘direct’ the clients investment portfolio as they, and often uniquely they, have the client context in mind. This suggests that offering tailored managed portfolio services (IMAs) is therefore also a far more attractive client relationship proposition than the distribution of ‘commodity’ products that are designed to service a market segment.

As Jon from Vivid has discovered, ‘The level of communication we provide is probably the key aspect of strengthening our client relationships. In otherwise difficult times we have been gratified to receive high quality referrals from our existing clients, which we see as the best endorsement that we are delivering the service that our clients are seeking.’

The favouring of IMAs doesn’t stop here. Not only are the client relationship management aspects of a ‘adviser direct to consumer’ IMA offer an increased opportunity for client service and deeper relationships, but also business risks and revenue opportunity looks to have some advantages also. Perhaps consider the following:

•

By offering an investment service directly to the

client, the advisory practice can get gross fee revenues from the provision of that service rather than trail commissions from a product, increasing revenue opportunity

•

By being involved in the ‘management’ of client portfolios, this may negate the need for all or some of the manufacturing margin paid to a fund manager (and possibly platform fees also), allowing the offering of the IMA at either a lower cost to the client, or perhaps retaining margin into the business to offer a higher quality service.

Not surprisingly, many advisers with appropriate skills in house are finding this approach attractive, however it is recognized that for many advisers, taking on this active advisory/portfolio management role may be a stretch. We are seeing two trends that are picking up in pace:

•

Some advisory groups are hiring specialist portfolio

manager / trader / researcher skill sets in house as part of a centralized team to either support advisers manage their portfolios, or form part of a centralized team that work with the advisers and manage their portfolios for them

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There are an increasing number of specialist ‘wholesale’ portfolio management groups that provide portfolio management / IMA services as a service to other advisory groups.

This is leading to some interesting industry dynamics forming by where either advisory groups are offering IMAs direct to the consumer with no external input, or they are developing collaborative relationships with specialist ‘wholesale’ IMA groups to do the work for them, yet not losing or assigning the client relationship or client management function. Like in many industries, I suspect that this ‘collaboration’ (as opposed to ‘distribution’) is going to be a critical part of the shaping of the industry in years to come.

Jon Reilly from Vivid Financial, who are starting to service not only their own clients with their own IMAs but also developing relationships with other advisory groups says ‘Whilst not every business will want to take on the investment management responsibilities for their client’s portfolios, managed accounts combined with the right technology means that it is possible for separate businesses

which introduces new skills, workflows, service levels and risks for a platform business, platforms already offer a large portion of the infrastructure to support the operation of IMAs by advisers and dealer groups, the key additional required piece being only to provide the portfolio modeling capabilities.

Supporting this possible extension by platforms is the fact that it is becoming an increasingly popular desire by advisory groups to have the portfolio modeling and manufacturing technologies required to operate IMAs tightly integrated with an administration platform. This allows IMA providers to deal with a single administration and technology supplier, which when combined can provide the key operational ingredients for advisors or their partners to operate IMAs for their clients.

Not only does the above approach by platforms reduce or even negate the sometimes challenging issues of integrating platforms and systems by advisers, portfolio managers or dealer groups, it transforms the platform from being just a provider of a commodity goods (i.e. administration services) to becoming a key integrated partner to their customers, increasing both their business value and also customer (and FUA) retention. I suspect we are could see this becoming the ‘norm’ for platforms in the next year to maintain competitiveness.

asset managers

A downturn in the global markets is not helping, but is not the only issue for asset managers these days. The powerful positioning and grasp of the platform industry is putting increased pressures on fund manager fees, as well as in some cases requiring ‘shelf fees’ to even get their fund products on the platforms. The platforms have become for many the ‘gate keepers’ to fund manag-ers as they not only are the administration platform to replace retail client service for fund managers, but also represent a hurdle for asset managers to get their product to advisory groups and investors.

Whilst one option is for an asset manager to set up or buy a platform in order to get access to retail markets, another solution may be to cut the platforms out and offer managed portfolio products and services instead, most likely with less overall costs, most likely less gatekeepers to deal with – and this is sounding attractive to many. Whilst many are starting to offer SMA products as they head down the path from funds to managed accounts, some of the more innovative ones may be seeking to look beyond ‘products’ and start to collaborate with advisers and dealer groups to help them offer IMAs direct to the client, after all the asset managers have the portfolio management skill sets, and the advisers have the client relationships suggesting an ideal fit.

As Roger Montgomery describes some of the benefits to asset managers, ‘Technology empowering managed accounts now makes it possible for boutique fund managers to profitably offer everyone and anyone access to their services and performance’.

to co-operate and provide investment services to the advantage of their clients. Scalability is the key to making sure that these businesses can grow in a sustainable manner, and it is technology that makes this possible’.

dealer groups

It is understood that many dealer groups in the country obtain funding to cover their costs via rebates from plat-forms or products, and a ‘cut’ of adviser fees.

With the trend of costs associated with the adminis-tration of securities for investors heading one way, and tending towards zero (perhaps look at the project AQUA initiative from the ASX), the dependency on platform rebates may have a limited life left. This raises the ques-tion for many dealer groups as to where to replace such funding and revenue from. Given the margin pressures on the product manufacturers, it may be unlikely that monies may come from there, suggesting that funds may have to come from adviser fees, surely only achievable if advisers can increase their fee cut too.

This is where IMAs look a favorable solution as under an IMA model, either:

•

the dealer group can participate in increased adviser fees by where the adviser operates a managed port-folio IMA service for clients, or

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the dealer can participate in helping the advisers do this, essentially being a service support system (and taking a fee for such) in helping the advisers operate IMAs.

Perhaps a new function of dealer groups in a world of IMAs is to collaboratively provide advisers with the core capabilities (research in the form of model portfolios, technology, and low cost efficient administration). We are starting to see a number of dealer groups go down this path, developing their role as practice tools supporters providing a framework for their advisers to operate higher value IMA services, or even managing the IMA portfolios themselves centrally yet in a highly collaborative manner with the advisers.

Whilst this may appear to many as being a change to the business model and represent some risks, the alternative is declining revenues and client control in offering commodity products, not to mention that the advisers may struggle to convince the clients to stay paying fees if they can source investments themselves over the Internet.

platforms

Whilst many platforms are ideally placed to offer SMAs (just add portfolio rebalancing technologies, a PDS and a selection of model portfolio providers to the platform and you are well on the way), and I suspect many will in the coming year or two, what is also becoming apparent is that they are also ideal to provide supporting services for the management of IMAs for advisers, or their selected portfolio management partners. The key difference and strength in doing this is that unlike offering an SMA

55 www.fssuper.com.au

Volume 04 Number 01 | 2012

Self-managed superannuation funds

Not only are such ‘collaborative’ relationships very ‘sticky’, but they are also likely to be able to offer an end investment product or service to the client at a lower cost, perhaps with investment administration and reporting of individual underlying securities performed on platforms. This change in dynamic then may reposition the administration platforms as exactly that, a place to hold and report on investments, side stepping the gate keeping role that they have had with controlling the funds on the platforms.

so what do you need to offer imas?

So if IMAs are so compelling a value proposition to the investors, the adviser and perhaps dealer groups also, what is holding everyone back? The answer to that lies probably in two key areas:

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the lack of available technology to date that has been able to support the complex calculations to perform individualized portfolio modeling and implementation with scale and efficiency

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the heavy entrenchment of the prior era’s business model of funds on platforms with their associated remuneration and rebate structures, possibly further enhanced with what many regard as a conflict of interests by where the organisations that own a lot of product manufacturing part (including SMAs) of the market also own the a lot of the ‘advice’ or ‘distribution’ part of the making, making it hard for a fundamental change in the broad based industry. However, we are seeing an ever increasing number of independent planning groups (and even advisers from tied groups) moving away from the old regime of funds on platforms to offering individually tailored portfolios (IMAs) for their clients providing a better value proposition for their client and their business at the same time.

In relation to the technology, there is no wonder that this has taken some time to get the market, it is not easy to even define what should happen in a portfolio to take into account a client’s current portfolio, a model portfolio, ratings on securities, and then many individual investment rules, preferences and constraints. Then try and do this for many client portfolios all at the same time – this is a serious data processing and workflow challenge, a ‘mathematical spaghetti’ says Roger Montgomery from Clime Asset Management. At Financial Simplicity this has taken us over 10 years to get right but is now proven and broadly available. Then there is the challenge of building such technology, supporting it, maintaining it, marketing it and providing it to businesses at an affordable price point, which I suspect is only achievable over the Internet. Given gravitation to the need for core competency focus in any business, I suspect for many that it is going to be a lot easier and cheaper for many to license this capability from specialist providers like Financial Simplicity rather than try and build it. Why wouldn’t you ?

So what are the key pieces that you need to offer IMAs. Generally these ‘ingredients’ fall into the following areas:

•

Investment research – often in the form of model

portfolios that can be constructed by in house teams or ‘bought in’ from the increasing number of provid-ers who are publishing such

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Somewhere to keep and report on the assets for the client – either a platform, custodian, nominee com-pany, broker or discount broker, each usually with a supporting cash account. This market is getting very competitive and we are finding that groups seeking outsourced administration are managing to secure such services at much less than a full WRAP price

•

Some form of licensing from ASIC to support the

mode of IMA that you are offering, whether it be dis-cretionary (where you may have authority to transact on behalf of the client’s account), or non discretion-ary (needing client approval for implementing each investment decision – although technically under the definitions offered by the Institute of Managed Account Providers a non discretionary offer is not a ‘managed account’)

•

Some way of ensuring that client portfolios can be modeled or kept in line with their selected model portfolios, usually in the form of a portfolio mod-eling technology, or should you be seeking to do this en-masse, a portfolio ‘manufacturing’ technology. The reason why technology is most often required is that dealing with many portfolios, each with indi-vidual securities, and doing calculations across them is a very data intensive task, where the computations required is vastly made more efficient (if not the only way to do this viably in a commercial manner) through the use of supporting technologies.

The impact of the reality that pretty well any group that has a base level of skills and access to the components above can manufacture and operate their own IMAs.

concerns over discretionary portfolio

management

Whilst the term ‘managed accounts’ implies discretionary authority by the portfolio manager, managed portfolios can be offered in an advisory fashion (non discretionary) also. However, we are finding that groups that are seeking to achieve fairness of client servicing (i.e. making sure that all clients are treated fairly rather than being in a ‘pecking order’) as well as operational efficiencies and prompt trading, are either currently operating, or seeking to move to a discretionary mode of operation. There are some considerable benefits to the clients and the advisory groups operating with a discretionary model (and to a large extent it is no different than putting monies into a managed fund where the fund manager has discretion) however there is also, quite rightly, some concern about the operation of discretionary portfolios given some disastrous cases of clients monies being lost in the past.

The quote The powerful positioning and grasp of the platform industry is putting increased pressures on fund manager fees, as well as in some cases requiring ‘shelf fees’ to even get their fund products on the platforms.

www.fssuper.com.au Volume 04 Number 01 | 2012 However, unlike many of these disastrous (and

often high profile) cases (some of which perhaps came about with what may be regarded as inappropriate discretionary trading which has impacted badly on both advisers, licensees and perhaps the industry also) the new form of IMAs where all trading decisions are made in the context of the chosen model portfolio and client profile may represent a very different, and perhaps lesser risk, compliance and risk management challenge and solution. The rationale here is that the discretion under a model portfolio based IMA offer is not so much about choosing which securities to trade and when (which may have been the characteristics of the high profile loss cases in the past), but actually is more about just authorizing an IMA portfolio manager to do their job under some defined parameters, the parameters defined by the clients current portfolio, their chosen model portfolio, and any specific rules, preferences or constraints that they client has defined. Perhaps there will be the notion of a ‘limited’ discretion license authorization available some time in the future to reflect the middle ground between total discretion and no discretion.

conclusion

We are in changing times in the retail investments industry. Many consumers appear to be getting smarter, becoming more informed and seeking answers to how to achieve the best tax and investment outcomes. Advisers and dealer groups are also becoming more informed, and have better access to tools and information than ever before. Product margins are becoming thinner everywhere and the regulators are starting to take a more pro-active examination of conflict of interest, and the sustainability and adequacy of retirement savings.

All these trends point to an emergence of a new way of delivering investment value that will bring collaboration between industry participants most likely on a single layer of investment administration, not separation of players and multiple layers of administration.

This new way of delivering investment value is most likely going to have to simultaneously address and improve transparency, liquidity, tax effectiveness, client service, reward for performance, sustainability, margin and compliance / risk management. To achieve all of this

though it is unlikely to come about from an incremental approach to product or service innovation, but more likely as a result of a whole new way of thinking about delivering investment value, a way that starts with the client and then allows the different skilled and valuable providers support them.

Whilst this way has actually been operating for some time, and is where the retail investment industry started, offering individual client tailored portfolio services by stockbrokers, this time may be different. I suspect that unlike the past, as Roger Montgomery points out ‘The most wealthy individuals in Australia, have hitherto been the only group with access to individually managed portfolios’, this time it will be a collaborative environment where clients, advisers, portfolio managers and researchers interact together leveraging the Internet to provide the client with the best IMA offering, and this time also at a price point that is affordable to the masses, with many anticipating and delivering such capability at much less than the understood industry average overall fee to client of between 2% and 3%. We are seeing a view that a more sustainable overall fee to clients being in the range of between 1% and 1.5%.

This is the growing world of new era IMAs. A new era that simultaneously can remove inefficiency from the value chain that is lost in ‘administration’ and also improve the servicing of clients in a compliant, risk managed, tailored, and yet scalable fashion.

This new era of IMAs transcends the scale solution of the last 20 years, that of producing commoditized products, by leveraging new technologies to do the complicated processing and decision support for each and all of the clients, rather than using technologies just to make the current process of product manufacture more efficient.

I guess time will tell how many of the investment advisory groups will move to this new era IMA segment of the industry, already estimated at between $40 and $80 billion in Australia alone (a fraction of the SMSF market one might notice), , however we at Financial Simplicity are seeing that, following the recent global financial crisis, an increasing number of people are thinking hard about their business models and client service value propositions, with the new era of IMAs being a very tempting, if not obvious way forward. fs

The quote This new way of delivering investment value is most likely going to have to simultaneously address and improve transparency, liquidity, tax effectiveness, client service, reward for performance, sustainability, margin and compliance / risk management.