Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 11

Wealth managers need a new car not a faster horse

“If I had asked people what they wanted, they would have said faster horses.” Henry Ford

“The market research is all in my head. You see, we create markets.” Akio Morita, Chairman, Sony

“People don’t know what they want until you show it to them.” Steve Jobs

Product innovations are rarely asked for or thought about by the general public. Inventors give consumers what they need without them realising that they need it. No-one ever said that they’d like a television, and Sony didn’t research potential demand for the stereo Walkman and it went on to revolutionise mobile music.

During the course of a financial year, I attend a great many fund manager presentations. In the most recent seminar I sat there thinking about how little innovation there had been in the managed funds industry in the last 15 years. Am I being harsh? Well, let’s think about it.

Most innovations happened years ago

In the early to mid-1980s when I first started investing, managed funds did not exist. Instead, a stockbroker managed your portfolio. It was inefficient and relatively expensive. Managed funds were truly an innovation. They pooled the money of many individuals and provided the benefits of economies of scale, diversification and professional management. Soon after, in the early 1990s, the ‘master fund’ was invented. Now referred to as ‘platforms’, they allowed people to invest in a number of different funds from different managers whilst providing consolidated reporting. Later, allocated pensions radically changed the ability of Australians to maximise their retirement money. These three drivers of the wealth industry were invented about 20 years ago.

Since then, just how much innovation has there been? Superficially you would think a massive amount, but how many are simply ‘line extensions’ such as long short funds, sector specific funds and some tweaking from platform providers. Colonial First State’s FirstChoice was undoubtedly innovative because it reduced the administration inefficiency and associated cost by creating pools of money instead of using third party wholesale funds. By doing so, clients are able to transact on the platform knowing they will get that day’s price and will receive a confirmation letter in a couple of days. All other platforms are simply a supermarket where you can buy other company’s wholesale funds. As such you are a hostage to that company’s administration and simple transactions can take more than a week to be actioned.

To date, the inefficiency elsewhere has perpetuated and no other institution has followed Colonial’s lead, as their platforms are tied into the old technology.

The really big innovation in recent times has been SMSFs, but for obvious reasons it wasn’t the managed fund industry that invented them. SMSFS are not just growing, they are taking off. Fuelled by a desire to take control and save money, they represent almost a third of the superannuation market and the largest segment. The fund manager response has been to promote managed funds to SMSFs, but the funds are seen as part of the problem not part of the solution.

An inflexible tax structure

And managed funds do have shortcomings. They have a trust structure, so at the end of every financial year, they are required to pay out any realised capital gains they make. If one’s objective is to invest for the long term, it’s not much help if you keep receiving taxable distributions every six months. And unfortunately, the better the performance is, the higher the distributions are. In an effort to ‘beat the index’ most active fund managers create major capital gains tax liabilities due to the incredibly high turnover (70% of the portfolio each year is not uncommon).

Some people may argue ETFs are an innovation, but they have the same legal structure and suffer the same tax fate as managed funds. Consequently, in my view they are not really much different to an index managed fund. For an individual tax payer, or an SMSF, buying shares directly means that capital gains and losses can be carefully controlled.

When you run your own SMSF, you are effectively combining your investments with those of the other members. This means you can efficiently manage the fund so that you minimise your tax. Not only did my family’s fund create sufficient franking credits to eradicate the tax on performance returns last year, it eradicated the contributions tax as well. And gave us a refund.

In 15 years of accumulating super in a managed fund that mostly invested in Australian shares, the 15% contributions tax was always deducted, never to be seen again. And I certainly never received a refund. Maybe I got some benefit in the unit price, but I doubt it. Most managed funds have such a large turnover in their portfolios that the capital gains tax on any profitable transactions eats up much of the franking credits.

Fees are too high relative to potential performance

What about the fees? Lately I have noticed an increased backlash from clients when they examine the fee structures. It is not uncommon for a global share fund to charge well over 2% per annum management fees, especially when performance fees are included. I defend many funds manager’s fees on the grounds that they have shown a historic ability to consistently beat the benchmark index. However, I recently saw a document in which one of Australia’s largest share fund managers stated a target return of 2% above the index before fees. This hardly seems a ‘stretch’ target and clients are often outraged that managers can skim off so much money for so little performance. The latest Morningstar survey on managed funds reports that the average manager in the majority of asset classes underperformed their benchmarks.

One notable recent development is ING's Living Super. The balanced option has no fees and a 50/50 cash and shares allocation, and it appeals to investors for whom perception is reality and they don't want to pay fees. The product actually pays for itself in the profit margin on the cash, which is a different approach to charging a management fee.

A growing percentage of Australians believe they can manage their own fund, outperform the professionals and save a bundle of fees. The chart below from Roy Morgan Research illustrates how poorly retail funds are perceived compared with SMSFs.

It’s debatable whether SMSFs actually do beat the professionals but the mere fact that fund managers can’t demonstrate their superiority is a worry. Surely with all that research capability and 40 hours a week at their disposal, the professionals must be able to find ‘hidden gems’ that the average part-time investor can’t?

Unfortunately, the chart below shows that the professionals are mostly investing in the household names that the average SMSF portfolio already has in its portfolio (AEQ is Australian Equities in the van Eyk universe).

When asked why they don’t invest more of the fund’s money in small companies, they suggest using their small cap fund.

But I don’t want to invest client’s money in a large cap fund and a small cap fund. I want to invest client money in a diversified portfolio of shares that delivers better returns than clients can themselves. The market is littered with Asian share funds that don’t invest in Japan, and global share funds that have no exposure to emerging markets.

In truth, some of these Australian share funds are so large that it is impossible to buy enough stock in a small to medium sized company to make a difference to their performance. Can they use derivatives to gain exposure? Some can, but most have strait-jacketed themselves by an overzealous trust deed. I don’t mind if a manager judiciously uses derivatives to increase their exposure without moving the market. Or sells short stocks they think will go down. After all, Platinum has been doing it for years with pretty good results. The irony is that in the eyes of many wealth managers Platinum is somehow cheating. Platinum’s really a hedge fund, they say, whereas we’re a diversified global share manager. This sort of thinking is the hallmark of production-led companies instead of marketing-led companies. And herein lies the problem.

Most wealth management corporations entrust their new product development to non marketing people. Sure, marketers are involved, but the major thrust seems to come from the ‘factory’ which designs a product they know they can easily make, and given to the marketing and distribution departments to sell. Contrast this with consumer goods companies where marketing departments use a blend of research and gut feel to design products that can increase their company’s market share, or better still, create an entirely new category.

The wealth management industry needs to make more serious attempts to find some new cars – otherwise they will be riding their horses into the sunset.

 


 

Leave a Comment:

     

RELATED ARTICLES

Worried about low rates, SMSFs drop banks and diversify

Five reasons SMSFs are making asset allocation changes

ETFs firmly established in the mainstream

banner

Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.