Much of the discussion around separately managed accounts (SMAs) in Australia is coming from commentators who point to the US market for evidence of their popularity. In particular, Cerulli and Forrester Research are regularly quoted on their predictions of rapid compound growth of the American SMA market. However, while the US market is interesting, it is arguably irrelevant to the Australian market. Why?
For starters, the American SMA market has largely been established by the large brokerage firms responding to customer demand to move from a fee per transaction model, to annual fees based on account balances. These firms found that they had an opportunity to add further value for the fee, and reduce risk by layering professional asset management processes over the top of the brokerage account.
However, while these brokerage firms dominate the US market with massive distribution capabilities and proprietary platforms — these platforms and business models are unlikely to scale down or be customised to Australian market requirements.
While the brokerage firms dominate the American SMA market, SMAs have also grown strongly in the traditional asset management firms offering individual mandates to the high-net-worth market. These asset management firms are now using their scale and platforms to migrate into the US retail market.
However, it is unlikely that the Australian high-net-worth segment will be large enough to interest these asset management firms. And for those that are interested, it is doubtful they will want to offer SMA products outside the high-net-worth segment.
The US market also has mature technology platforms supporting SMA products. The platforms provide new SMA operators with access to large scale operating technology platforms that allow them to establish new products without the massive investment required to establish an entirely new technology platform.
As these platforms have been established based on US market requirements, features to deal with foreign currency, Australian tax and Australian regulatory requirements are either not supported in these systems or have yet to be proven in the Australian market.
While the US experience may not be directly relevant to the Australian market, it does not mean that SMAs will not establish themselves here. In fact, SMAs are already well-established in some segments.
The diagram (bottom right) shows a model for characterising existing offerings in the Australian market.
The dimension across the top is who is making the investment decision, and dimension down the side is the client balance. For our purposes, the distinction between a retail investor and high-net-worth investor is the definition of a sophisticated investor, proprietary portfolio management means the asset managers are affiliated with the SMA product provider, and open architecture is the opposite — the asset managers are unaffiliated with the platform provider.
Looking at the model, the adviser/broker discretionary segment describes arrangements where an investor authorises another person to make investment management decisions on their behalf on their equities portfolio.
Examples include: (1) a stockbroker buying and selling on behalf of the investor based on an in-house asset management model, and (2) an arrangement where a financial planner buys and sells stocks inside a client’s wrap account either directly or using a model portfolio tool.
The key characteristic of this type of SMA is that the person providing the investment advice is trading on the individual account under authority given by the investor. This is an approach that works well for a highly personalised investment service and is offered across all balance ranges. However, it does not scale well, because there are only so many accounts an individual can practically manage.
SMA offerings where professional portfolio managers are making investment decisions can be divided into the proprietary and open architecture segments. The proprietary approach is where in-house asset management skills are made available to individuals via a separately managed account — usually in an effort to gain additional distribution for the home team that normally operate managed fund portfolios.
There are also some offerings emerging that offer manager selection on the same platform, however, due to the difficulty of scaling existing investment management processes down to the retail market, these offerings are usually constrained to high-net-worth and private banking clients.
There are a small number of cases where a proprietary offering is offered to retail investors, however, the attractiveness of the product is limited to a small segment of the market that are happy with the single manager approach.
The open architecture retail offering is a platform-based offering providing retail investors with a selection of best of breed asset managers, independent of the platform operator. This is the retail SMA — the new and unexplored territory in Australia.
However, while it is still new and unexplored territory, it is a product whose time has come. The retail financial services industry has in place large-scale investment management platforms such as wraps, and e-commerce servicing infrastructure, and access to technology and processes that can facilitate the delivery of a product that requires a fundamental re-engineering of current investment management and client servicing infrastructure.
For retail SMA products to succeed, they will need to offer investors and their advisers all of the benefits of a high-net-worth SMA, while also being accessible through, and serviced by, the same channels currently distributing managed fund products.
Some believe retail SMAs will not offer the same benefits as the high-net-worth offering because decision-making processes are applied using model portfolios rather than a specialist portfolio manager who takes into account the personal circumstances of each investor. However, this argument assumes that all of the advantages of an SMA come from customised tax management and bespoke investment decision-making processes.
This is not true — if you are a retail investor who does not qualify for access to a high-net-worth SMA product yet, you can gain access to a product that provides the same professional asset management processes as a managed fund, holds assets in a structure that isolates the investor from the trading activities of others, enables portfolio adjustments to be automatically traded in a manner most tax advantageous to the individual, and provides the ability to customise and control the assets held in their portfolio, then the better structure and process of a retail SMA offers considerable additional value when compared to an equivalent managed fund investment.
This raises the final question — how are SMAs to be positioned relative to managed fund products?
While many argue the imminent death of managed funds, this is an overstatement. Retail SMAs will simultaneously compete with, and complement managed funds.
Over time, SMAs will compete as the product of choice for access to Australian equity investments and progressively take a larger role due to better tax efficiency and control. However, they will also be a complement to managed funds, as in the near term, SMAs will only be offered based on Australian listed securities, and some products such as hedge funds are more suited to distribution via a managed fund structure rather than an IMA structure.
So don’t lament the death of the managed fund — news of their death has been greatly exaggerated. However, managed funds are not the last word as the best way for retail investors to access professional investment management — SMAs are a product whose time has arrived.
Peter Horne is product and developmentsenior vice-president at BT FinancialGroup.
