In our last note on this topic, we discussed the significant advantages of Multi-Asset managed accounts that incorporate direct securities from the perspective of enhancing an adviser’s value proposition and addressing regulatory and competitive pressures. In this note we now look at the investment case for this approach.
Investment advantages of greater transparency
The most obvious characteristic of multi-asset portfolios that incorporate direct securities is greater transparency. However the benefit of additional transparency goes beyond the investor simply knowing which stocks they own. It also extends to two of the core aims of retail portfolio management, that is, the capacity for improved risk/return outcomes and higher after-tax returns.
Top to bottom risk analysis – a whole of Portfolio approach
Providing the MDA/SMA manager has direct securities expertise and the right quantitative tools at their disposal, the increased granularity of a direct securities approach allows the manager to more accurately measure and monitor overall portfolio risk. This is because portfolio risk is more than just how the different headline asset classes or funds behave relative to one another, but also how the individual underlying assets themselves behave, down to the security level. For example, a Balanced portfolio with an Australian equities allocation that is overweight in a sector which is highly correlated to international equities will contain significantly more downside equity risk than a Balanced portfolio tilted the opposite way. This is despite both portfolios potentially having the same headline asset allocation. In that regard the manager with greater transparency is arguably in a much better position to optimise the overall risk/return ratio of the multi-asset portfolio.
This increased ability to risk measure the portfolio from “top to bottom” and take a whole of portfolio approach is particularly useful during times of market stress. As direct securities managers are more acutely aware of the underlying exposures, they are in a position to more accurately monitor the cross-correlations imbedded within the portfolio, and how those correlations are changing through time.
This type of in-depth quantitative analysis is much more difficult under a “fund of fund” managed account approach, due to the unitised structure of managed funds. The opaqueness in this case is exacerbated by the fact that many underlying active fund managers can be protective when it comes to disclosing details of their holdings. Instead “fund of fund” managed account managers are usually forced to rely on what the underlying fund manager tells them, in terms of their risk exposures and fund characteristics.
Investors must also be cognisant that third party underlying active managers will be focussed primarily on their own benchmark, rather than the greater interests of the multi-asset portfolio. Indeed each underlying manager has no knowledge of any other holdings in the multi-asset portfolio outside of their own allocation. This includes managers of outsourced direct equity SMA “sleeves”.
It is partly for the reasons outlined above that many large industry super funds have begun in-housing their asset management, rather than allocating out all of the different asset class exposures to third party managers. It is not solely a cost exercise.
It is important to point emphasize that the construction of a Multi-Asset SMA that incorporates direct securities into its core investment process demands the requisite skills; hence it is prudent to seek managers who come from a direct funds management or securities analysis background.
The ability to accurately identify strong performing external managers should not be disparaged however. Indeed it is a requisite skillset for any multi-asset manager, including those that internalise components of their active management. One example where this skillset is required is in Alternatives, where typically Hedge Funds are employed, and selected based on process, transparency, management, cost and track record. A deep quantitative understanding of contrarian, trend following, and other common approaches is essential when selecting and combining appropriate strategies.
Improved After-tax returns
There are tax advantages to incorporating direct securities into multi-asset portfolios. Rather than merely owning units in a trust, the client maintains beneficial ownership of the assets held directly. This can provide material benefits in the form of capital gains tax minimisation. Latest generation platforms and accounting software packages usually allow for easy and automated tax optimisation when it comes to CGT parcel selection, improving after-tax returns. In addition, the ability to in-specie transfer existing holdings in or out of the managed account structure without requiring a sale can avoid unnecessary tax events.
Technology – The great enabler
Perhaps the main reason why this type of solution is only now coming to the fore is due to substantial advances in technology across the industry. This applies at the investment level, the platform level and at the business level more generally.
Firstly, advances in data extraction and quantitative investment techniques have significantly reduced some of the costs traditionally associated with direct securities investment management. Instead of requiring large teams of expensive analysts, an investment manager with the right skillset and tools can now extract and process large datasets of financial information to generate alpha-delivering portfolios at a much lower cost. When these costs savings are passed onto the end client, all members of the retail investment value chain can benefit.
Secondly, the ongoing platform arms race has meant that most retail platform providers can now accommodate fast and efficient processing of direct equities holdings and trades at cost effective prices. The removal of minimum trading fees in favour of fixed percentages within most SMA structures means that lack of diversification is no longer an issue. Relatively small parcels of shares can be held with no increase to portfolio cost. Further, CGT parcel optimisation and other useful tools provided by these platforms are perfectly suited to direct holdings, helping to enhance after tax returns.
Finally, innovations in business communication methods, such as automated emails and text messages, videoconferencing and portable devices can help SMA managers communicate same-day trading decisions and regular updates to advisers. Advisers can then use these same methods to keep their clients informed, requiring a minimal time investment. Not only does this enhance client engagement, but it also helps cement the adviser’s ongoing role as the trusted adviser.
Future proofing your business
In summary, in a world where client Best Interests are paramount, Multi-Asset Managed Accounts that incorporate direct securities can provide unparalleled advantages to advisers and their clients. Reduced costs associated with internalising active management can place them at a price point close to passive solutions, whilst still providing alpha opportunities normally associated with active funds. Further, increased transparency allows for improved risk management, the potential for better after-tax outcomes and greater client engagement opportunities.
If you would like to speak to Resonant about its Multi-Asset Managed Accounts that incorporate direct securities, please get in contact.
Resonant Asset Management Pty Ltd, ABN 41 619 513 076, trading as Resonant, AFSL No 511759.
Disclaimer: The Information within this article does not constitute personal financial advice. In preparing this document, Resonant has not taken into account your particular goals and objectives, anticipated resources, current situation or attitudes. You should therefore consider the appropriateness of the material, in light of your own objectives, financial situation or needs, before taking any action. You should also obtain a copy of the PDS of any products referenced before making any decisions. The data, information and research commentary in this document (“Information”) may be derived from information obtained from other parties which cannot be verified by Resonant and therefore is not guaranteed to be complete or accurate, and Resonant accepts no liability for errors or omissions. Resonant does not guarantee the performance of any fund, stock or the return of an investor’s capital. Past performance is not a reliable indicator of future performance.