Not all investment managers and consultants are the same. In this final instalment of a two-part series, Innova’s Dan Miles considers the benefits, and risks, they bring to managed accounts.
Managed accounts are here to stay but it takes a thorough due diligence process to find the right platform and investment partner to manage clients’ money.
Get the decision right and clients can benefit from highly tailored portfolios wrapped in a transparent and tax-efficient managed account structure. Similarly, get it wrong and clients can pay a heavy price.
Innova has had a range of questions asked – and not asked – by those assessing our investment managed account services. Asking the hard questions before committing to an investment partner can improve performance and potentially avert disaster.
Operational due diligence – often overlooked
Most dealer groups, consultants and advisers consider investment philosophy, process, portfolio composition and performance, but pay little attention to an investment manager’s operational capabilities.
The prudential regulator has been pushing for greater operational due diligence on investment managers since at least 2014 and the Australian Institute of Superannuation Trustees has recently released a new guidance note on this for super funds.
It’s clear that these types of questions are not always being asked – and they should be. Having run money across multiple platforms for multiple clients, we’re acutely aware of what is needed to do it properly.
If the investment manager runs portfolios on multiple managed account platforms on behalf of several clients, it may be able to help a dealer group select a platform. However, this path can also add operational complexity.
A manager or consultant can certainly help practices and dealer groups assess the many complex factors involved in setting up a managed account. However, if the manager or consultant only ever recommends one platform – the one they work with – that’s a red flag.
All platforms are slightly different and offer a variety of functions and features, some of which may be a benefit or burden depending on individual circumstances. A one-size-fits-all approach is unlikely to be in the best interests of all dealer groups, practices and their clients.
Different platforms have different rules and different portfolios will have different exposures. Does the manager have an operational resource to manage this or are the analysts (or worse, the portfolio managers) expected to manage implementation across various clients and platforms? Some managers may attempt to cut corners even further by allocating the duties of analyst, portfolio manager and operations manager to one person.
An investment manager needs a dedicated operations resource, preferably bolstered by a business intelligence package that automates execution by incorporating the different rules and preferences of all clients and platform mandates.
Does the manager have the resources to offer a full range of asset classes within their portfolios? As mentioned in the first article in this series, there’s no need for managed accounts to be restricted to Australian equities alone – that greatly limits the benefits that can be obtained by going down the managed account path.
Poor operational management is a factor behind investment managers delivering sub-par returns, deviating from intended risk profiles or, in a worst-case scenario, collapsing.
It takes experience and resources to show investment and operational skill. Have the investment managers managed money before or are they using portfolio models (without having demonstrated operational expertise) as part of their pitch? In other words, are they showing you the performance of actual client money or just a theoretical model portfolio?
If they haven’t run money previously, caution is warranted. Unfortunately, they’re in a position where they don’t know what they don’t know.
Investment philosophy and performance: dig deeper
Many investors will start by considering managers’ investment approach. They should have an easy-to-explain philosophy that aligns with yours and your clients’. It’s important that they’re pragmatic, too. Can they articulate market environments that can hurt their particular approach? Irrational exuberance is never a sound strategy.
Evidence is crucial to back up their claims. Most managers will be able to roll out a portfolio track record that has beaten the benchmark, but that may be underpinned by excessive risk, higher market exposure or just plain luck.
Quantitative managers should be able to back-test their performance out-of-sample, but other managers will need to rely on their philosophy. (When you ask the manager whether their back-tests are done ‘out-of-sample’, if they don’t know what you’re asking, that’s a pretty clear sign you shouldn’t use them. Out-of-sample means the tests weren’t retro-fitted to give good results. In other words, the models were designed first, then tested consistently across multiple markets and time periods, irrespective of the results.)
Do they add value through asset allocation, manager selection or both? If it’s qualitative asset allocation, how are they making those decisions and can they provide evidence that the approach they follow adds value? If they’re using macroeconomic inputs and economic forecasts as the primary driver for their decisions, be wary, as economic growth is a poor forecaster of investment returns.
If manager selection is their focus, do they concentrate on a particular style that has been shown to outperform over the long term (such as value in equities) or do they blend everything together and hope they can pick outperforming managers in all styles?
Combining all styles, such as value, growth, and neutral, will underperform the market on average after fees, so they’ll need to find superior managers to outperform.
Some investment philosophies may not be a match for the fully transparent nature of managed accounts. For example, a value or contrarian equity mandate will, by definition, own out-of-favour stocks that may be in the headlines for all the wrong reasons and over-sold. Some of them will end up being bad investments, some of them fantastic, but trying to explain to clients that they should look at the portfolio performance and not individual holdings may be a difficult conversation.
Investment managers that use underlying active managers should be able to use their leverage to negotiate fee discounts on your behalf. If they don’t, what is their rationale for keeping fee discounts for themselves (like a typical multi-manager)?
Not all platforms can facilitate fee discounts, which is why it can pay to go with someone who knows the different platforms.
It always pays to ask the right questions.