Feature Stories | May 31 2006
By Greg Peel
How is your super fund performing? Those who prefer to keep track of such things will notice that 2005-06 has been a particularly good year in funds management, which is comforting given that the market has been running hard and that previous years have been very poor for the industry.
The SuperRatings survey of balanced funds completed in April shows an average return of 15.9%, although May will knock a few points off to bring results closer to a 13% return for the year. This matches similar returns in 2004-05 and 2003-04, but is much healthier than the dark years of 2001-03 where single digit averages, and some individual fund negative returns, were the norm.
The dark years went a long way to alerting the average Australian that superannuation was not a given, but a risk business like anything else. To sit back and ignore super until the day of retirement was to naively expect all would be right with the world. Suddenly Australians were questioning whether large pooled super funds were the only place to keeps one’s retirement nest egg, and whether other opportunities existed.
One opportunity was to self-manage one’s super, even if this meant handing over actual management to an expert. Australians wanted to take more control over their retirement funds, and one way was to get more directly involved. This was a step along an evolutionary path of direct share ownership that has grown into an industry of its own today.
The Australian market did not participate markedly in the tech bubble, it being more of an American thing, so the last great bull market for Australian stocks was the one that ended abruptly in 1987. The bull market we hope we are still in now, while impressive, as yet pales into insignificance compared to the eighties (the market quadrupled within the decade). But back in 1987, only 9% of Australians actually owned shares.
That is, only 9% directly owned shares – the balance of Australians’ holdings were in public superannuation funds. When the stock market crashed in 1987 everyone was worried, but not many knew why. As so few Australians actually had any cause to watch the stock market, it was all a bit of a mystery.
In the nineties, indifference towards direct share ownership from individuals began to abate as the great privatisation push began. The Commonwealth Bank (CBA), Qantas (QAN), GIO (AMP), the TAB (TAB) and most of Telstra (TLS) were sold off to the public and the likes of the AMP (AMP) were demutualised. Suddenly, everyone was in on the act and direct share ownership by Australians jumped enormously. By 2003, 37% of Australians directly owned shares.
This evolution brought the stock market into focus for the average Australian who to date had considered the stock market the preserve of the independently wealthy. Fuelling the interest was the tech revolution, which soon provided the ability to buy and sell stocks via an internet platform for minimal brokerage, and without having to talk to a stock broker. Anyone with a connection could now "play" the stock market.
Around about the same time two things were happening. One was that economists were beginning to warn more and more about Australia’s ageing population, and that if the government did not start giving this serious consideration then there may be insufficient funds to provide age pensions in the future. Australia had made superannuation compulsory in 1992, but this was not going to be enough by itself.
The other was that a weak couple of years for the stock market brought into focus that super funds were performing poorly. Australians were retiring only to find their contributions had actually been eroded at the final payout, and not enhanced. The industry was under the spotlight, and unit holders wanted to know just what was going on behind the scenes.
While the general public was airing its grievances, the high end of the market was, as always, untroubled. While high-earning professionals may well have been making some limited contribution to a company superannuation scheme, they were also "playing" the market directly. This may have been for short term gain, or it may have been for ultimate wealth growth using, for example, a family trust as the vehicle.
Because the high end has significant amounts to play with, stock brokers have always taken notice. Retail stockbroking grew enormously in Australia to match the rise in direct share interest, but your 100 Telstra shares was never going to guarantee you any particular service from your stockbroker beyond the obligatory. The high end, on the other hand, was able to hand over money to a trusted stockbroker to invest at discretion. It was in the broker’s interest to put together a portfolio which would maximise the client’s returns.
Supporting the ease with which clients could hand over responsibility to their trusted broker was the rapid growth of paperless technology that quickly did away with the need for scrip certificates or even exchanging cheques. Funds could be moved in and out of cash and stocks with ease and the client would simply receive a statement at the end.
Self-funded superannuation is thus a boon to the wealthy for the above reasons, but also for the fact that large pooled superannuation funds carry many disadvantages for long term investment.
The average superannuation fund unit holder is invested in a balanced fund – one that apportions investment amongst a diversified, low risk portfolio of stocks, bonds and cash. These are the funds that look like returning about 13% this year. But the S&P ASX 200 index is up some 20% this year, and although the stock market has been the place to have one’s money of late, that’s not how a balanced fund operates.
Even if one chooses to direct one’s super to an equity only fund, it is the goal of most equity super funds to track the index, rather than materially outperform it. Hence if the stock market does go down, equity funds will go down with it. Another disadvantage is that equity funds can be so large that they cannot make portfolio adjustments without moving the market to do so, rendering them destined to always achieve the worst possible price for a trade.
Large superannuation funds have always had the goal of attracting the greatest amount of investors’ money they can, but in so doing they become lumbering behemoths trying to be all things to all people. Enter the boutique fund.
Boutique fund managers are not new, but their number has exploded in recent years. As an alternative to large pooled funds, boutique funds offer more specialised investment options such as stock picking (as opposed to index tracking), specific risk/reward profiles, the use of derivatives for protection or enhancement, and the ability to dart in and out of the market without moving prices in any material way.
The growth of such funds has been fuelled by many factors – dissatisfaction with large funds, greater interest in the stock market per se, technology that greatly reduces set up costs, and the sheer talent of many in the industry that felt they could offer a better product by themselves rather than being tied to a large fund.
For those who decided to become more pro-active in the management of one’s own super, smaller managed funds became an opportunity to do just that.
For the average Australian there was still one drawback – to have one’s money managed by a talented boutique fund one still had to start with relatively large amounts of money – perhaps a million dollars. For the smaller investor, this was still a bar too high. Larger fund managers responded by offering a more diverse suite of investment products than simply the large balanced funds, allowing those with lesser means to be more selective in their own investment choices.
Enter financial planners. Financial planners have been around for a long time too, but as large funds managers began to dominate the market in providing various investment products at the lower end, financial planning was also swallowed up to a great degree by the fund managers themselves. Come and talk to our financial planning advisor – he has all the products you might need.
Again there was a problem. Investors soon recognised that to one-stop-shop and one institution meant only having that institution’s products forced upon you, whether those products were performing well or not. There was little opportunity to shop around. Funds also pay commissions to financial planners for the sale of their products, and hence the "independence" of financial planner advice is brought into question.
The next step in the evolutionary process was the "wrap" account. Wrap accounts freed up funds management at the lower end from being tied to one institution’s products alone. Through wrap accounts, investors can place their money in not just one managed fund, but in several from competing institutions and thereby both diversify their risk and shake off the concept of having products forced upon them.
The investor was getting closer and closer to gaining control over superannuation and stock market investment as all the parts were falling into place. Managed funds offered diversified investment profiles. Wrap accounts offered access to more than one manager. While Australians were continuing to take more interest in the stock market directly, vehicles to serve the purpose were evolving and entry levels were coming down. More Australians could join their higher end counterparts.
By 2004, 55% of adult Australians – 8 million people – owned shares. This included direct holding of stocks, or indirect holdings through managed funds. It included personal super funds but not public super funds. This was a far cry from the 9% of 1987.
The wealth of the average Australian had also increased markedly through property appreciation, and that wealth had also been transferred to some extent into the stock market as property prices peaked. Everything seemed to be going swimmingly, but there were still problems. One of the biggest problems was tax.
When one enters a managed fund as a form of direct share investment, one becomes a unit holder in the entire fund, not an individual holder of shares. This means any capital gain already in the fund is apportioned to all, no matter what the entry time. Thus unit holders run the risk of receiving distributions from a fund when they are not wanted, and crystallising a capital gain which then attracts tax. This may be a big slug to overall returns.
The problem is only exacerbated by wrap accounts. While it is nice to have the diversity, moving in and out of different funds only means attracting more and more adverse tax effects. Furthermore, individuals have different requirements for dividend treatment. Franking credits are a powerful offset for taxable income, but a managed fund does not tailor franking requirements for the individual within the fund.
Then there are fees. Different funds have different approaches to fees. There may be entry fees, exit fees, management fees (and don’t forget brokerage) and also performance fees. Adding up tax disadvantages, and the capacity to stack up large fee obligations while moving money around, and it seems to be that the best way to manage one’s own money is to simply play the market oneself.
The problem is that despite the increased focus on the stock market from the average Australian, not many people have the expertise, the information, or even the time to wring the best possible return out of a self-managed superannuation fund. But evolution has seen to that.
Enter the Separately Managed Account, or SMA. Investment in an SMA is more akin to holding an individual portfolio. The label implies your account is separately managed from the pooled fund. And in the case of an SMA, you actually own the shares – in a managed fund a custodian stands between you and beneficial ownership.
SMAs offer a client a selection of share portfolios to choose from which will feature varying risk/reward profiles and perhaps lean toward differing tax requirements. An expert selects and manages that portfolio, and each client is considered to have held the shares only from entry. In other words, capital gain is not pooled amongst all the clients in the account to the detriment of an individual.
Boutique funds managers have returned to the fore in offering such products, and rarely are any two exactly alike. Competition ensures that fee structures are not exploitative, and entry levels for some styles of SMA have dropped as low as $25-50,000. It is still a rule, however, that the more you invest the better service you will receive.
But wait, there’s more. A further step up in the chain from the SMA is the IMA, or Individually Managed Account. While the distinctions between an SMA and an IMA can be fairly grey, the general point of difference is that within an IMA a client can more specifically tailor a portfolio. For example, a client can elect to remove or add particular stocks within the given portfolio.
Furthermore, as an IMA is strictly individual then even more individual consideration can be given to a client’s own tax situation.
NextFinancial is one boutique manager which has been offering SMA/IMA products, in some form, for several years, and with varying entry levels. NextFinancial’s Peter Kennedy highlights the value of such products compared to wrap accounts, where a trustee must stand in the middle. Direct share ownership removes the need for complex software systems that can take 12 months to develop, and which even to day lack the sophistication to provide seamlessly efficient interaction.
Having said that, it is notable that Australia’s sophistication to date in the field has outstripped that of the US. Managed accounts have exploded in the US, now boasting US$1.9 trillion of investment, with a 15% per annum growth rate. An equivalent explosion is yet to occur in Australia, and yet by all reports this country is better developed from a software point of view to handle all the aspects of trading and accounting that managed accounts require.
"Tax is clearly one of the biggest issues in the move towards managed accounts", says Kennedy. Not so important, he believes, is the need for a client to manipulate a portfolio on their own initiative. "You are paying an expert to provide you with the service", he says, "so why dismiss his expertise?"
Adam Dawes of Shaw Stockbroking does not disagree, but notes there is a certain comfort level in a client knowing they can move stocks in and out, without penalty, if they so desire. "They need not use the facility", says Dawes, "but they know its there".
Shaw Stockbroking has just joined other brokers (as opposed to managers) in offering an IMA product. Brokers, including Shaw have offered such a service for decades, but are now looking to "package" the concept for wider appeal. A managed account is simply what our high end investors were enjoying previously as outlined earlier in this article.
The Australian Stock Exchange reports that as of June 2005 there were 308,000 self-managed super funds in Australia, and the number was growing at 1,800 per month. This represents some $165 billion in assets. The average total assets of a self-managed super fund member has grown from $184,490 in June 2000 to $285,420 in June 2005. By comparison, the average assets of a public super fund member is $40,000.
Important in the growth has been the ongoing development of managed accounts. The IMA, in particular, is a response to the financial planner’s dilemma. As more Australians are wanting to control their own super through direct share investment, the financial planner has been called upon to become an overnight expert in stock selection, not just an astute selector of available managed funds.
Financial planners are not experts in the field. They do not receive the wealth of research generated by managers and stock brokers and do not necessarily have ASIC compliance to be able to give advise on specific stock market trading in the first place.
Compliance is an important consideration in the funds management industry. Candidates now undergo a rigorous education and testing program before being allowed to deal with the public and continuous reporting is strictly demanded.
An individual does not need to comply to manage his own money, but again, how many individuals have the resources, or even the time, to manage important investments effectively? Shaw’s Adam Dawes sees managed accounts as the big growth industry in funds management. Shaw has recently launched an IMA product comparable to similar products offered by stock brokers in the market – Macquarie and Merrill Lynch for example.
Shaw’s product has an entry requirement of $200,000, compared to most at $500,000, which for what Shaw believes is the first time brings entry level into the realm of the average Australian (the ASX figures are testament to this). As with others, Shaw offers an internet interface where a client can track performance.
There is nothing otherwise particularly unique about Shaw’s IMA, and boutique fund managers such as NextFinancial and many, many others offer tailored products with a varying range of entry levels attracting a varying range of service. Competition will no doubt ensure that the growing interest in such products from the Australian public will result in the most efficient outcome.
Notwithstanding such competition, the sort of services that fund mangers and stockbrokers can provide through managed accounts cannot be provided cheaply, and so can never be offered at ridiculous prices to a client. A client is paying for years of expertise not only in stock selection, but in tax management, account management and reporting, and ongoing software development.
But the evolution of these services has followed the evolution of the Australian public, looking to maximise wealth through at least one asset class – equity. Never before has the operation of the stock market been so visible, and so accessible. Direct share ownership is now very much a part of the Australian investment landscape.