While originally marketed to high-net-worth clients in the mid 90s, ‘managed accounts’ are gradually becoming one of the most talked-about financial products in Australia. Professional portfolio management, customisation, tax efficiency and direct/beneficial ownership are some of the features promoted by managed account providers.
But can managed accounts really leave clients in a better position?
Under the existing safe harbour provision, advisers are required to conduct a reasonable investigation into the financial products that might achieve the client’s financial needs and objectives.
With an increasing service offering in the managed accounts space, advisers are therefore required to think outside the traditional model, understand and consider these products before making a product recommendation.
This represents a business opportunity for advisers, but a compliance pitfall if it is not done correctly.
Understanding the client’s real needs
Part of the adviser’s obligations to comply with the best interests duty is to clearly articulate how the financial strategy might be achieved and the client’s objectives met by investing into the recommended product. The advantages of using a managed account over, for example, a unitised fund with a comparable investment strategy, can only be explained if the adviser has a good understanding of the client’s goals and financial situation.
That is to say, in order to justify a product recommendation, advisers should have a clear understanding of the client’s:
- financial goals;
- desire to minimise fees and costs;
- existing investment portfolio;
- need to ‘cash in’ the investment;
- tax position; and
- risk tolerance.
After confirming this information, advisers can individually assess the benefits and disadvantages of recommending a managed account while discarding other alternative products (e.g. master trusts, managed funds, wraps accounts etc).
For example, managed accounts allow clients to have direct ownership or a beneficial interest (through a custodian) of their own portfolio. This can be advantageous because it is the client’s individual tax position that governs the taxable outcome, not the structure. This benefit cannot be found in managed funds where the underlying asset is held by the trust fund and a capital gains tax event is always triggered after the sale of assets by the fund manager. In essence, managed accounts can potentially deliver better outcomes for the client (after-costs and tax), and as such, they should be considered when providing tax-effective strategies (within the boundaries of tax financial advice).
It is the adviser’s obligation to understand the client’s real needs and consider them against the benefits offered by managed accounts. An adviser must reasonably believe that the client is likely to be in a better position if the client follows his recommendation.
Switching to a managed account
Advisers are also required to conduct a reasonable investigation into the financial products that might achieve the client’s financial objectives. Even though this requirement is scalable to the complexity of the advice, a comprehensive understanding of the products available at the time of advice is always required.
This represents an important compliance pitfall when reviewing existing clients, because existing products must be reconsidered in light of any new recommendation, the volatility of any investment returns and the change in the client’s goals or financial circumstances.
When reviewing existing clients, advisers must consider the benefits and disadvantages (including the costs and risks) of switching the existing product to a new product that could potentially leave the client in a better position.
One important benefit promoted by managed accounts providers is that their cost is generally lower than managed funds.
Advancements in technology have made managed accounts more affordable for the average investor while eliminating extra costs applicable to more traditional structures (e.g. unit trust administration fees). Therefore, administration, investment management and broking costs need to be compared against more traditional products when considering a switch for fee-sensitive clients or underperforming portfolios.
Even though cost reductions is usually a good reason for switching a product, the potential increase/decrease of the client’s investment risk exposure by going from a managed fund to a managed account must be considered. Switching advice is only appropriate if it would be reasonable to conclude that the net benefits (not just the cost) that are likely to result from the new investment option are better than under the existing one.
This compliance pitfall can be mitigated by having a clear understanding of the client’s risk tolerance, product preference and overall financial goals whilst correctly disclosing the risk and other consequences of the switch.
Consider the risk
As previously noted, the benefits of a managed account will be dictated by the client’s goals and financial situation at the time of advice. Another important benefits not offered by more traditional products is the level of customisation and direct/beneficial ownership.
Managed accounts can be customised for each individual client, more so than traditional managed funds. For example, by allowing minimum security holding locks and/or security substitution within an individual client portfolio. This functionality makes managed accounts more attractive for savvy clients or SMSFs.
However, managed accounts providers predominantly use listed securities and exchange-traded funds. This potential lack of diversification needs to be highlighted and addressed individually in the product recommendation advice. To manage this risk, some providers use cash and managed funds within models to ensure asset class diversification is achieved. These options should be considered against the client’s risk profile and existing investments.
The potential lack of diversification and higher direct securities exposure make managed accounts inappropriate for risk adverse clients (although defensive models are offered by most managed account providers).
A better outcome for clients?
From a client’s perspective, the decision to enter into a financial strategy usually revolves around: cost, performance and risk. Managed accounts might not be suitable for all clients, but their benefits should be examined for appropriateness when conducting annual reviews or providing new financial advice.
In order to ease a client’s concern, good quality product advice should address the following questions:
- How does it work?
- How will the client benefit from it?
- How much does it cost?
- Can I support my statements with facts and figures?
This process also allows advisers to educate their clients on products and strategies they do not know much about, resulting in an increase of trust.
Managed accounts can potentially deliver a better outcome at a lower cost whilst being professionally managed by an investment manager. However, they should only be recommended after having a clear understanding of the client’s goals and relevant circumstances.
