There has been a significant move by many financial planning firms away from managed funds and into Separately Managed Accounts (SMA), and related structures such as Individually Managed Accounts (IMA) or Direct Managed Accounts (DMA). These structures are designed to avoid some of the shortcomings of pooled managed funds, such as distribution to new investors of capital gains earned in prior periods.  Also, cash managed funds cannot take advantage of retail ‘blackboard specials’, where banks issue term deposits to retail customers at attractive rates. IMAs in particular are specifically tailor-made for individual investors, whereas SMAs may be more focussed on model portfolios.

Ability to tailor individual advice

An SMA or IMA is a portfolio designed for a specific investor, with shares and other investments selected by a manager according to a model portfolio or other stock-picking technique. Investments are held separately in the name of the investor, so the pooling effects of managed funds are avoided. Reporting and tax outcomes are individually designed, with the investor as the beneficial owner.

These structures seek the best returns for their investors, and in the cash and term deposit market, the highest yields come from direct investment into banks, not into managed funds. For example, the wholesale 90 day bank bill rate is currently about 2.8%, but term deposits of a similar maturity are still paying over 4%.

Broad meaning of financial institution

In the updated bank liquidity regulations released on 6 May 2013, APRA seeks to clarify the meaning of the term ‘financial institution’. This is vital because deposits from financial institutions receive a less favourable liquidity treatment than sources identified as retail, considered the most reliable of funding sources for a bank.

APRA states (first in the context of responses to its November 2011 paper):

“A number of submissions sought clarity on the definition of a financial institution, expressing concern that the definition in draft APS 210 was too broad. APRA has recently released Prudential Standard APS 001 Definitions, which includes a definition of financial institutions. Most entities noted as being financial institutions in the previous draft APS 210 are covered in that definition. APRA will use that definition in APS 210 but, for the sake of clarity, will make specific reference to money market corporations, finance companies, superannuation/pension funds, public unit trusts/mutual funds, cash management trusts and friendly societies.”

So what exactly does Prudential Standard APS 001 Definitions say here (my emphasis)?

“Financial institution includes any institution engaged substantively in one or more of the following activities – banking; leasing; issuing credit cards; portfolio management (including asset management and funds management); management of securitisation schemes; equity and/or debt securities, futures and commodity trading and broking; custodial and safekeeping services; insurance (both general and life) and similar activities that are ancillary to the conduct of these activities. A financial institution includes any authorised NOHC or overseas equivalent.”

This definition could push MDAs, IMAs and MDAs into the financial institution bucket, reducing the opportunity for these structures to access retail deposit rates.

Furthermore, the catch-all “similar activities that are ancillary to the conduct of these activities” could push the boundary even further, into Power of Attorney, general custody and any arrangement where the investment is made by an institution under a general instruction from a retail client.

Advice businesses which manage accounts on behalf of clients and rely on term deposits to improve returns should worry how far APRA pushes this revised prudential standard.