The institutionalisation of retail financial advice is here, and the managed accounts structure is the trojan horse that has brought this institutional mindset – and indeed pricing – to advisers’ gates.
The discounts being offered by investment product providers to financial advice intermediaries during the last 18 months – which are funnelled back to clients in the form of rebates – are changing the game.
Not only are these rebates making the adoption of managed accounts more attractive, they’re also giving licensees and portfolio managers a seat at the negotiating table with product providers, and with a lot more leverage than they’ve ever had.
The commercial dynamic for managed accounts started changing about a year and a half ago when the structures started proliferating and pressure began building on product providers to offer discounts.
It was towards the end of 2017 when Schroders released an internal paper on how the evolution of managed accounts was changing retail product pricing, a topic Graham Mather, director and head of distribution at Schroders, recalls wasn’t seriously being look at.
“When we put our internal whitepaper together 18 months ago there was nobody that we knew of in the market that had different pricing structures for managed accounts,” Mather says, “So it’s interesting that it sounds like that’s changed significantly and fund managers are now more willing to have the conversation.”
In the two years self-licensed advice firm Stanford Brown has been operating its managed account solution, the firm’s chief executive, Jonathan Hoyle, says fund managers have become much more pliable on pricing.
“Fund managers are much more willing to negotiate on their management expense ratio when the funds are invested in a managed account,” he says.
Hoyle’s colleague at Stanford Brown, director of investments Vincent O’Neill, confirms that the rebate phenomenon is a relatively new one.
“When we were having the conversation two years ago those rebates weren’t there. Our clients that joined up when we started managed accounts two years ago are benefiting from those rebates now,” O’Neill states.
Opinions vary on just how much sharper the discounts are for products going into managed account structures.
Brett Baker, a director at investment consultancy Evergreen, says rebates being offered by providers for financial products plugging into managed account solutions ranges between 10 and 15 per cent.
Stanford Brown’s Hoyle says the overall discount can be about 25 per cent from the headline retail rate. Others say up to 30 per cent.
The complex nature of the managed accounts structure makes comparisons of discounts and features difficult to benchmark. Separately managed accounts (SMAs), individually managed accounts (IMAs), and managed discretionary accounts (MDAs) are all unique products with separate legal structures, and a range of people could sit across from a fund manager negotiating discounts. It could be a licensee’s investment officer for an MDA, a provider’s portfolio manager for an SMA, or a consultant like Evergreen’s Baker who works with advice practices to build all three types of these investment solutions together.
This intertwined web is what the institutionalisation of retail looks like.
Scale is the key ingredient managed account products bring to the retail market, and the primary
reason fund manager discounts are possible.
According to the Institute of Managed Account Professionals’ latest FUM census, $62.12 billion was invested in domestic managed accounts as at December 2018. Researcher Investment Trends says the use of managed accounts has increased for seven consecutive years, with 35 per cent of advisers recommending them compared to 16 per cent in 2012.
For many product providers, the greater the quantum of FUM, the sharper the discount. The traditional way advisers construct investment portfolios leads to a transactional outcome for investment firms, because funds sit on a shelf until they’re selected to fulfil a style or asset class allocation. Fund flows happen in dribs and drabs.
Plugging into a managed account offering for the product provider means it is part of the production line, so the quantum builds immediately. As long as it delivers on returns, regular asset rebalancing effectively ensures the product maintains its allotted percentage of the pie.
Mather says this production line approach is why managed accounts are so attractive to investment firms.
“They are institutional in nature, so there is immediate scale and a larger investment,” Mather
Hoyle agrees: “…most rebates are related to the anticipated flow into the fund,” he says. Tiered discounts, according to scale, are nothing new. What is new, however, is how deep the tiers are getting for managed account products.
Mather says the contributing factor to this discounting trend is the reduced service costs for the provider; if the investment vehicle is a managed account Schroders only has to deal with the investment committee and come to an agreement, instead of haggling on individual tranches of product.
“The alternative is if a dealer group has a long APL, [whereby] the fund manager would need to assist the various individual financial planners… thus requiring more resources,” Mather explains.
Technology providers and managed accounts advocates highlight the agility and efficiency of the managed account structures.
Andrew Alcock, chief executive of platform provider HUB24, notes that “tax modelling, parcel management and optimisation” are features the structure enables which can improve financial outcomes for clients.
“Concessions from fund managers only adds to that pile [of outcomes] and enhances the managed account proposition,” Alcock says.
In theory, the fund rebates garnered by the managed account structures are passed on to the client – particularly as this structure is in a relatively early stage of its evolution and advisers are likely keen to satisfy best interest duty, which includes ensuring their advice leaves clients in a better position.
This is generally the case, yet there is scope for a licensee to negotiate a better product discount and raise their managed account fee in tandem so they are the ones benefiting, not the client.
Assuming that rebates always flow back to the client is dangerous, according to Ian Knox, advisers licensee Paragem’s founder and chairman.
“If reduced costs can be used to featherbed the operating system or reduce advice costs then I think we’re going to have a problem,” Knox says.
The potential for conflict here isn’t necessarily a cause for alarm, says Simon Carrodus, a lawyer at The Fold Legal. Speaking at the IMAP conference in Sydney, Carrodus said “any time you recommend an in-house product – including a managed account – a conflict arises”.
Commissioner Hayne made clear in his final report that the important thing is that these conflicts are “managed”. Yet conflicts can’t simply be managed by telling advisers to do the right thing, and certainly not by disclosure. For managed account advisers, it’s about making conflicts as innocuous as you can.
“As far as reasonably possible, conflicts should be eliminated,” Hayne notes.
AT A DISADVANTAGE
A potential downside to discounted pricing on products destined for managed accounts is that the clients who remain on traditional wrap platforms may be penalised.
Schroders’ Mather says there is “no getting away from” the fact that clients on managed accounts are easier and more efficient to manage.
Hub24’s Alcock agrees that avoiding managed accounts could lead to client penalties in the form of higher fees, but says the impetus should be on the adviser to make an inarguable case for them.
“If you’re not on managed accounts and your adviser doesn’t understand their value you’re potentially at a disadvantage,” he says.
Advice firms will likely – and in some corners already have – start charging the clients that wish to remain on less efficient investment platforms in a different way. These clients may avoid the murky waters of managed account fees and rebates, but higher flat advice fees could be the price of staying in the old world.
Portfolio managers also need to be wary of putting the search for better rebates before best-practice portfolio constructions principles, according to HUB24’s Alcock.
“Don’t go hunting for a fee discount at the expense of the right decisions in terms of portfolio construction and the right investment fundamentals,” Alcock advises.
Paragem’s Knox agrees. An interesting discussion, he says, is whether fund managers are being selected “on the merits of their capability or on their price”.
“That’s a healthy debate because most fund managers tell us that when they lose [deals] it’s based on the fact that they wouldn’t do rebates,” Knox says.
Another variable is that not all platforms can actually facilitate the rebate of discounts.
“Not all platforms are created the same when it comes to handling rebates,” Hoyle says.
What seems like a relatively easy task for highly functional platforms – rebating a predefined fee percentage back to the cash account – is often not available, further skewing the decision making of portfolio managers.
“You need a really good platform to run those administrative capabilities,” says Hub24’s Alcock.
“Not everyone can handle that.”
The move towards better pricing for products on managed accounts is gaining momentum, but not all providers see significant value in differentiating between platform types. Johan De Lange, chief operating officer at fund manager Allan Gray, says his team remains agnostic.
“We haven’t changed our value proposition since managed accounts became more popular,” he says.
De Lange explains that Allan Gray has a product disclosure statement they’ve maintained “since day one”. There is a discount for scale, but at $50 million the bar is set high. Ultimately, he says, the type of platform the investment is housed in shouldn’t matter.
“Our mantra is that all businesses that invest the same amount should pay the same,” he says.
“It’s not for us to judge what clients qualify for it and what clients don’t.”
De Lange isn’t alone. Vanguard and PIMCO are – anecdotally at least – not prepared to give discounts via rebates, regardless of the amount invested or the platform they are invested on.
Domestic providers Magellan and Platinum Asset Management are likewise known for their resolute attitude to pricing.
Whether these hold-out managers offer discounts in the future or other funds come to market offering deeper discounts remains to be seen.