As part of their value-add, financial planners are increasingly putting in the time to build direct share portfolios for their clients. Are direct investments the new cool? Benjamin Levy reports.
Growth in direct equities is fast becoming a permanent feature of the investment landscape.
It almost doesn’t matter if markets are up or down, or if investor confidence is at record lows or not; the march towards direct equities dominance over the asset landscape is continuing unabated.
Self-managed super funds (SMSF), as one of the largest users of direct shares, are continuing to expand.
Add in an increasing focus on the client segment that uses direct shares the most – high-net-worth clients – and the growth of direct shares is guaranteed.
Platforms and software providers are expanding their services as fast as they can to make sure that direct share portfolios are as easy to build as possible, while brokers, fund managers and platforms are scrapping for total control over where advisers access them.
However, the fight over high-value clients is leaving the average investor to fend for themselves, while business development managers and institutions could come under pressure.
Simply a flesh wound
It increasingly feels like the direct equities sector is inhabiting a different reality to the rest of the financial services industry.
In the real world, the wider financial services industry has been struggling with investor sentiment that has been improving at a snail’s pace over the last year, and continued investor slothfulness.
Coredata’s Investor sentiment index for the last quarter of 2011 showed that investors were less confident about markets than they were during the global financial crisis. It got so bad that the index hit the lowest point for investor sentiment in its history, at minus 22.4.
By April, the negative sentiment had improved slightly, rising to minus 16.8. But it was still the eighth consecutive quarter where the index has been negative.
Sentiment improved further to minus 9.9 during the third quarter of this year, but investors have still been unwilling to get back into the market. CoreData head of advice, wealth and super Kristen Turnbull warned in September that investment intentions remain low.
The past several years of volatility have left investors cautious about backing their instincts and getting back in the market, she said.
But in the world of direct equities, things seem much brighter. The massive plunge in investor sentiment at the end of 2011 barely slowed direct equities growth at all.
To the middle of 2011, the percentage of new client money going into direct equities and ETFs was 23 per cent. By April 2012 it had only dropped by four per cent.
In comparison, the amount of new inflows into managed funds fell by 10 per cent over the same period.
But both the absolute amount of direct shares, and the proportion of money invested in direct shares in platforms, has increased over the last 12 months, according to MLC executive manager of investment platforms, Michael Clancy.
While the amount invested in direct shares depends a lot on market sentiment, that was a short-term impact that would not impact the upwards trend of direct share ownership, Clancy says.
There is still strong support from advisers and clients for investment in direct shares, he says.
“Because of the huge flow into cash and term deposits, the growth in direct equities stalled, but it’s expected to resume once the markets start sorting themselves out,” says Investment Trends senior analyst Recep Peker.
Advisers expect to be putting 30 per cent of new client money into direct equities in three years, according to Investment Trends.
Ease of construction
The upwards trend of direct share ownership is being facilitated by ease of access. Nearly all the platforms are offering direct share capability, while software companies are branching out into direct share portfolio construction.
Instreet managing director George Lucas recently attributed the growing interest in direct equities to technology changes.
Planners can now buy advanced software off the shelf, rather than having to use a platform, he said.
The existing software companies are also seeing a boom in demand for direct share software.
IRESS business development executive Todd Yarrow recently noted increasing demand from planners for the company’s trading, reporting and online portal services.
Advisers were choosing to use the direct equities features rather than data feeding and managed funds services, Yarrow said.
The direct equities option is becoming easier to implement, according to Andrew Bird, Australian executive director of online portfolio management company Sharesight.
There are many more portfolio management companies that now offer direct equity portfolio construction, solving the traditional difficulties surrounding the effort needed to construct a diversified portfolio and how to gain exposure to global equities or bonds.
Planners are also more willing to put in the time to build a direct share portfolio, Bird says.
“There are a couple of strands that are coming together,” he says.
Platforms and financial institutions have spent vast amounts of money in recent years upgrading their direct share offerings.
BT Wrap users have access to bulk trading capabilities and same day trading ability, while Macquarie Adviser Services head of insurance and platforms Justin Delaney said last year that interest in direct shares was growing because of the level of functionality offered by the company’s platform.
Macquarie released the latest version of its online tax return tool, Sharemarket Tax Facts, last month.
While the tool was created to help accountants complete annual SMSF tax returns, Macquarie Adviser Services executive director Carolyn Colley says the company has also seen interest in the tool from advisers.
Tax Facts is an increasingly useful tool for SMSF professionals to use as the SMSF industry grows and investors continue to hold a significant proportion of their portfolio in direct shares, Colley said.
Product providers are also responding to the expansion by introducing more and more exchange-traded fund products, allowing even more comprehensive direct equity portfolios to be built by advisers.
Direct share products are expanding at such a pace that the industry has begun to use them as a measure of investor sentiment.
Betashares head of investment strategy Drew Corbett suggested recently that large outflows from its Chinese economy ETF in June were triggered by reports of a slowdown in the Chinese manufacturing sector.
Turnover of its US dollar ETF tripled in May this year after a weakening of the Australian dollar, while the most popular product continues to be the high-interest cash ETF.
Corbett uses the data to suggest that investors are behaving defensively, staying with familiar asset classes and looking for yield.
Inflows into the ETF market are becoming a useful way to gauge investor sentiment, he said.
SMSFs and high net worth clients
The rapidly expanding suite of software products and platform capabilities are squarely aimed at two valuable types of clients – the SMSF sector and high net worth clients.
High net worths and superannuation are two deep drivers of growth in the direct share industry, according to Clancy.
A large proportion of the liquid wealth of high net worth clients is in shares, and as their wealth grows, so will their direct share allocation.
At the same time, as the public becomes more engaged and more educated with either public sector super or SMSFs, there will be an increased proportion of super being allocated to direct shares, Clancy says.
Figures provided by Multiport demonstrate the monopoly that direct shares hold over SMSFs. Approximately 36 per cent of money in SMSFs is invested in Australian shares.
Of that, 32 per cent is invested in direct shares, and four per cent is held in managed funds. Investment Trends research shows an even higher allocation than Multiport of 41 per cent to direct shares within SMSFs.
These two sectors of the market frequently overlap.
According to Peker, half the number of advisers who provide advice on direct shares do so for SMSFs, while the type of clients that planners provide advice on direct shares to are those with more than $100,000 in investment assets.
“It tends to be higher net worth investors who are interested in equities and have the appetite for it, and the cost savings are proportionately more significant for them,” Bird says.
The cost savings are one of the big reasons high net worth clients are relatively easier for advisers and the industry to target.
An investment fee of 2 per cent for a managed portfolio of at least $1,000,000 would cost $20,000. That fee can be halved using direct shares instead.
SMSFs also go hand in hand with increased control. Higher value clients typically establish SMSFs for control and more transparency, and direct equities can give them those exact qualities, Lucas says.
The direct equities market remains closed to your average investor
However, targeting high net worth clients comes at the expense of the more average investor. Direct equities continue to be inaccessible for lower value clients.
“There are very, very few advisers who say they recommend direct equities to clients with less than $100,000 of investment assets,” Peker says.
Investing in direct shares often results in a significant home country bias. Building a more diverse portfolio of international shares is often much harder and more expensive for the investor.
So investors already need to have very substantial scale before they commit too much to building a serious direct investment portfolio.
“For the vast majority of people, professionally managed funds provide a fantastic source of exposure to investment talent, and diversification, and professional investment that is a much better solution for them,” Clancy says.
Theoretically, if costs were to drop substantially, it would open opportunities for more people to take up direct shares, but some sectors of the market such as brokerages have been under pricing pressure for most of the last decade, and are already reducing costs.
“It’s probably at a point where it can’t go down much more,” Clancy says.
Investors always have to measure the trade-off of return, risk and cost to investing, he adds.
However, Bird believes that planners can become more efficient in implementing direct equities, which will provide cost savings for investors.
“The reality is that the savings proportionately are just as relevant for a smaller investor as for a bigger one, and I think planners need better systems or more efficient ways of implementing them to make it worthwhile,” he says.
IRESS’s Yarrow said recently that the biggest stumbling block for planners was to do with administration and volume.
It wasn’t typically worthwhile for an adviser to run direct equities unless they hired someone to do the administration, but software can help smaller practices which want to run direct equities, he says.
Yarrow acknowledged that a planner just starting out would probably be better going into managed funds, but that may not be what the client wants, he said.
“These days you’ve got to give them what they want,” he added.
But advisers tend to ignore the smaller value client on direct equities because of the simple reason that they don’t have enough money to be already interested or engaged with their investments.
SMSF members by their nature are going to take a pretty close interest in how their assets are looked after because of the large amount of money involved.
Advisers and institutions also educate high value clients because of self-interest. A wealthy client who becomes engaged through seminars often ends up hiring the company to advise him on his investments.
But a client with $20,000 in their super isn’t going to have that high a level of engagement to make it worthwhile for advisers, according to Multiport technical services director Philip La Greca.
“Financial institutions are not running benevolent societies,” La Greca says.
Generating income drives direct equities
The main drivers behind building a direct equities portfolio are beginning to shift. Recent Investment Trends research shows that generating income has displaced cost-effectiveness as the top reason for buying direct equities.
Two thirds cite dividends and franking credits as the main reasons, with cost cutting coming second at 55 per cent and transparency coming third at 53 per cent.
Two years ago, capital growth was one of the biggest reasons for investing in direct shares. Now, that only sits at 40 per cent.
SMSFs are mostly responsible for that shift. They are turning to more defensive outcomes, worrying about generating a good level of income rather than growth.
The share market has gone up by six per cent since July. The amount of Australian shares in SMSF’s should have gone up to 38 per cent by now, but it hasn’t.
Investors are buying constantly traded shares instead, where they don’t need to be as concerned about the capital exposure but still get a good trade-off on the income generation.
“If you think about the dividend yields that you’re getting out of those types of stocks like Telstra, the two retailers, and the four banks, you’re getting a nice dividend yield out of it, particularly if you’re getting the franking credits as well,” La Greca says.
Because interest rates are going down, investors are being forced to look for other sources of income, and the yield on well-known stocks is pretty good, Bird says.
Being in control
With direct equities turning into an essential investment asset for investors, different sections of the industry are scrambling to become the primary access point for direct equities.
MLC recently reduced the rate for direct share trades on its online brokerage platform nabtrade to $14.95 per trade for amounts under $10,000 in an effort to attract more investors, trumpeting that they were offering the lowest charge among the major banks.
They also redesigned the platforms watch-list, which allows traders to collate the stocks that they watch.
Some fund managers want to control the process from start to finish. Instreet Investment recently announced its intentions to try acquire a private client stockbroking firm to offer direct equities to advisers.
The firm was looking at practices in the range of $7 million to $10 million of revenue.
Private stockbroking firms can deliver services direct to the independent financial advice market , which is particularly appealing given the rapid growth in the SMSF sector, Lucas said.
However, Instreet has been forced to broaden its approach after running into difficulties finding stockbroking firms to buy.
The problems were mostly because of market conditions, Lucas says.
The firm is now looking at building the capabilities internally from scratch, rather than buying in the expertise, he adds.
For all the effort by the brokerages and asset managers to dominate the access points for direct equities, the number of advisers using those avenues has remained static over the last few years.
There are as many advisers using one solution as there are using two, according to Peker.
Investment Tends research shows that wraps and platforms have the strongest grip on accessing direct equities, with 62 per cent of advisers using them.
Forty per cent of advisers use a full-service stockbroker, while 37 per cent use an online broker.
But the platforms can take heart. If advisers had to choose one avenue to use, 43 per cent of advisers say the investment platform is their single most preferred access point for equities.
Advice firms are still working through the practicalities of accessing direct equities, according to Macquarie Practice Consulting associate director Fiona Mackenzie.
Macquarie Practice Consulting’s 2012 Financial Planning Practices Benchmarking survey found that 29 per cent of advisers choose stocks themselves, 27 per cent use exchange-traded funds, while 26 per cent managed the investment with the support of a broker.
Some fund managers are attempting to increase their own business by discouraging advisers from managing investments through online brokerages.
Tyndall Asset Management director Mike Davis recently warned that clients will get what they pay for if a planner regurgitates information from a broker without using dedicated research and transactional capabilities.
With the proper research, they may do as well as a fund manager over the long term, he said.
Thus, there is a need for SMSF investors to go to external managers, Davis warned.
“Clearly that’s a bit self-serving, but that’s one of the areas that we intend to target through our multi-manager capability and alternative assets capability,” he said.
A number of other fund managers have also warned that advisers against doing it on their own.
Advisers are using rules of thumb to manage risk, rather than doing it on an analytical basis, according to Lucas.
Advisers have traditionally relied on fund managers to develop a risk-weighted portfolio, but now that they they’re doing it themselves, the risks of investing in equities are not being adequately communicated to advisers, he says.
They probably don’t realise the different tools that institutional fund managers are using to measure risk, Lucas says.
Unless advisers do the research themselves, they have to buy someone’s equities expertise when they start to move beyond the top 10 stocks on the Australian Securities Exchange, La Greca says.
Bird echoes La Greca’s concerns.
Finding high yield stocks can be easy, but that doesn’t mean that they’re stable. Investors have to be careful about what is in their portfolio, he says.
Implications for the industry
The growth of the direct equities space has big implications for certain sectors of the industry.
A number of business development managers (BDMs) who have recently been made redundant are struggling to find their way back into the industry, and direct equities are partly to blame.
With high net worth clients demanding direct equities and individually managed accounts, managed funds have become yesterday’s news, reducing the need for BDMs.
Institutions will also suffer, with the traditional make-up of the constructed balanced fund coming under pressure.
The industry may start to see the dismantling of fund structures in favour of “building block funds”.
“You can have a pure equity fund, a pure fixed interest fund, a cash fund, an international shares fund, a property fund and then you can build based on your own idea of what you want,” La Greca says.
However, others believe the institutions could play a central role in this revolution. They are the only ones who have the ability to produce these building block products in bulk and market them.
Elements of that approach are already present in the superannuation space, but it can easily be applied to non-super, by providing an online, do-it-yourself experience that pulls together the elements you need, rather than requiring a planner or the investor himself to put it together, Bird says.