Connie McKeage

OneVue Holdings Limited (OneVue) last week agreed to acquire Select Asset Management Limited, trading as Select Fund Services and Select Investment Partners Limited.

Select Fund Services (SAML) is a specialist provider of responsible entity (RE) services and one of Australia’s leading REs for multi-asset trusts. The business also provides services to leading single strategy managers and access to Australia via unit trust fiduciary services for global offshore groups.

Select Fund Services acts as RE for groups such as Neuberger Berman and Smarter Money Investments (50% owned by Yellow Brick Road) who are also clients of OneVue. It has a 12 year track record in fiduciary and RE services with a stable and experienced operations, technology and compliance team.

Select Investment Partners (SIPL) is a specialist multi-asset investment manager and implemented portfolio consultant with a track record of over 12 years managing diversified multi-asset portfolios. The business is based in Sydney with 15 people. SIPL works with financial planners to enable them to offer Customised Portfolios to their clients.

“The acquisition follows OneVue’s stated objective to grow the company organically and acquisitively and is strategically important in delivering value added services to both OneVue’s Fund Services and Platform Services’ clients“, said Connie Mckeage, CEO of OneVue.

The consideration for the Select businesses will be paid $2.7m in cash and $4.3m in OneVue scrip.There is also an incentive component, payable in scrip, for total revenue growth above an agreed threshold in Select Investment Partners during FY2015. Shares issued will have an escrow period of up to 12 months. The cash component will be funded from existing cash holdings.

Brendan Foley, Chairman and CEO of Select, said, “Having worked successfully with OneVue over the last year on a range of projects from unit registry and mFund services to the development of a managed account solution for our customised portfolio solutions, we have seen the complementary nature of our respective client lists and service offerings. By merging the businesses, the current value propositions for our respective clients will be enhanced.”

Select and OneVue are complementary businesses. SIPL strengthens OneVue’s superannuation trustee business, MAP Funds Management. SAML’s services enhance OneVue’s existing Fund Services offering by creating a broader suite of unit registry, RE services and mFund distribution.One of the cornerstones of the transaction is the strong cultural fit of the businesses, and that OneVue’s management capabilities are broadened and deepened.

The acquisition is expected to deliver a number of key financial benefits for OneVue:

• Retail Funds Under Management and Administration (FUMA) will increase from $1,940m to $2,609m (Excludes one asset consulting contract prior to the acquisition advised as winding up in Nov 2014)
• Total Funds under Supervision (FUS) from RE and trustee services will increase from $711m to $1,614m as at June 2014
• Select’s consolidated revenue was $7.1m in FY 2014. Revenue included incentive fees earned in the Investment Partners business of $1.6m and paid on returns in excess of a bank bill benchmark
• OneVue expects that the transaction will be accretive on an EBITDA per share basis in FY2015
• Revenue impact by offering RE services as part of a broader offering to domestic and international custodians and investment managers
• Cost and capital synergies identified

Select employees will join OneVue at their Sydney office. Brendan Foley, Chairman and Chief Executive Officer of Select, will be appointed Deputy CEO of OneVue and two other Select directors will be appointed to the executive team.

“This acquisition will enable us to more effectively deliver a broader range of client solutions. I welcome our new shareholders and I am delighted to be working with a team of people who are aligned with the OneVue team in their thinking and equally committed to making a difference” Connie Mckeage, CEO of OneVue, concluded.

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The search for the ultimate ‘system’ of efficient portfolio construction and ongoing management has led to some interesting innovations. Here, Select Asset Management’s Alex Wise looks at the evolution of the underlying product structure with an eye to the top-line investor benefit.

Efficiencies in portfolio management have long been a goal of savvy investors and their financial adviser. But today we are shackled with the onerous task of reporting compliance, Dreaded paperwork. The process of completing a Statement of Advice (SoA) for material changes or a Record of Advice (RoA) for minor changes each time a change in investment is required is a tedious and intensive process for all concerned.  Moreover, client investments may be put at risk when markets begin to gyrate. Advisers may not produce timely, written advice to be acted upon quickly enough in order to protect clients. Similarly, clients are often unable to take advantage of short-term mispricing opportunities.

Solution? Two investment structure approaches have evolved to provide a more responsive investment solution for clients. They are, firstly, the use of a multi-asset unit trust as a core portfolio tool and, secondly, the use of managed discretionary accounts (MDAs), while an increasing number of advisers are considering a hybrid solution as the best of both worlds.

Managed Discretionary Accounts

MDAs are provided by a financial planning, fund management or brokerage house – each working as an MDA operator (“Operator”).  Typically an Operator manages a portfolio of equities for a client on an individual or model basis, although solutions exist encompassing other non-equity assets.  A client gives the Operator discretionary authority to make and implement investment decisions on his or her behalf. Importantly, client approval is not required for each investment decision.  This also means that reporting requirements to clients can be simplified and the Financial Planner is not required to  to engage the client in advance each time an investment decision is made.

Certain MDAs can be tailored specifically to the requirements of each individual client. Bespoke MDAs, called individually managed accounts (IMA), require higher minimum investment amounts in order to be practical. More commonly the MDA operator will apply the same investment decisions to multiple client accounts according to a model portfolio i.e. a separately managed account (SMA). Importantly, from a legal perspective, the client holds a direct legal or beneficial interest in the underlying assets within the MDA. This is distinct from managed investment schemes where the underlying assets are held by a unit trust, and the client has a direct interest (a unit) in that trust.

For clients with larger balances, the MDA offers increased control, however, the expense associated with operating an MDA have made it impractical and commercially challenging for small to mid-size clients to get the benefits of a tailored MDA.  Clients with larger sums to invest are able to take more or less risk depending on their appetite or investment preferences – for example, financial securities could be excluded from a bespoke MDA account; perhaps not a bad thing given current valuations!

Some MDAs can offer portfolio protection via derivatives or options strategies.  However, these protections are not available to all clients as they depend on the Operator’s regulatory status and whether they can transact derivatives on behalf of their clients.  Many fund managers and financial planners acting as MDA operators don’t have the necessary licence to use derivatives or options.  This can leave clients exposed without portfolio protection in times of market volatility.  However, for those clients that benefit from an Operator with derivatives experience, market protection strategies can insulate portfolio returns from severe downturns in market values. All with the attendant risks, of course!

Importantly, the tax impacts of investment decisions remain specific to each client.  This means that the Operator ensures that the client’s tax consequences are insulated against the impact of other investors.  Unit trusts offer a similar outcome for all clients.

It is worth noting that many Operators have a lack of experience outside of equity securities.  This can leave clients facing low or non existent access to  bond and other markets (as well as derivatives outlined above).

One further criticism of MDAs is that they usually do not allow access to global investment markets and outcomes.  Whilst many investors are satisfied having 100% of their investment outcome linked to the ASX, many others are now seeking exposure to fixed income or Term Deposits. Global equity markets – including established markets like the US – or more exotic emerging market locations may be in favour.

Additionally, incentives for MDA operators have also been called into question by some observers.  The use of brokerage commission as a remuneration tool has been linked with an incentive to churn the portfolio, meaning that clients will participate in more trades to generate higher commission for the Operator or their affiliate.

Detractors of the MDA model also point to the lack of accessible performance data.  Unlike unit trusts which have audited track records, the performance of MDA operators on a risk-adjusted basis is less clear.

The universe of fund managers operating MDAs is relatively small except in the case of Australian Equity managers.

Many skilled fund managers generating market outperformance or alpha can be difficult or impossible to access via an MDA, particularly the universe of high quality offshore managers. As such, MDAs can also offer access into unit trusts to access these high quality managers. However, even access to these managers via a unit trust can be fraught with difficulty as many highly skilled managers have high entry levels precluding MDAs from rebalancing into these managers.

For the Financial Planning business considering operating an MDA the costs can be high. Australia’s regulatory authority, ASIC, is considering implementing higher minimum capital requirements for MDA operators which may deter many prospective Operators from offering MDA solutions.  Many Operators also suffer from internal costs associated with reporting. Clients who require customised portfolio reporting creates a business drag on the desired scale efficiencies in reporting, including performance and portfolio reporting. 

Multi-Asset Unit Trust

Many financial planners are also utilising or considering the use of a multi-asset unit trust to act as a core portfolio.  Like an MDA, the discretion to make investments is vested with an investment manager which can be the financial planning group or a third party manager.  This obviates the need to make ROAs and SOAs every time a change in investment is required.

The unit trust would then make investments into third party fund managers or direct assets that can be based in Australia or offshore. Groups that utilise the unit trust solution enjoy the ability to access any investment fund anywhere in the world.

Whilst this approach requires research, many unit trust sponsors will utilise an asset consultant or third party manager to implement research on these funds.

Endowment ‘likes’

Access to the global talent pool is important for investors who seek to diversify their returns from solely Australian equities or fixed income.  Many sophisticated investors are now looking for “endowment like” portfolios that deliver long term returns. These investors view the ASX as being increasingly volatile and the access to unique investment strategies offshore can reduce overall portfolio volatility over time.

Access to market protection is also a key selling point of a unit trust with a unit trust operator being able to hedge foreign exchange, interest rate and market exposure.  These traits are important for those seeking endowment like characteristics.

Responsible entities of unit trusts are subject to rigorous supervision from the ASIC.  Supervision visits and high regulatory capital requirements mean that responsible entities operating a unit trust are subject to higher regulatory standards than MDA operators.

Unit trust structures do come at a price however, and the fixed costs of operating a unit trust can preclude access from smaller groups with small amounts of funds under management.  Whilst providers such as Custodians and Auditors offer protection to investors, they charge additional costs which are typically recharged to unit holders.  Moreover, any third party responsible entities or asset consultants will need to receive fees for their services.

Additionally, ownership of the underlying assets is co-mingled and clients hold units in a trust rather than the underlying investments.  As such investors are subject to the redemption rules of the unit trust rather than having the ability to sell investments directly into the market.

Summary

Whilst MDAs and Unit Trusts deliver significant efficiencies to clients and advisers, both also bring  pros and cons which should be understood prior to embarking on either strategy.  The ability to access a global investment talent pool through a unit trust is tempered by the lack of direct ownership of investments and additional costs.

The MDA often lacks ability to enact portfolio protection from violent swings in foreign exchange rate, interest rate or market movements.  Additionally, the limited pool for accessing investment ideas through an MDA can be off-putting for some clients.  Many financial planning groups are proposing solutions that include a unit trust for a core portfolio but on an MDA platform for satellite investments so that benefits of both can be realised.

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Looking beyond the Hedge.

Advisers and their retail clients cast a wary eye whenever the expression ‘hedge fund’ is raised.

Why so? Institutional investors have embraced alternative investing with great vigour, while the regulator, ASIC, has recently allayed fears concerning the underlying liquidity and gearing levels of Australian hedge funds. Alex Wise gives an insider’s view on the journey for hedging from lowbrow blunt instrument to today’s legitimate tool in the investor portfolio kit bag.

The alternative investment industry has grown substantially in size since the lows of the GFC (from a low of around USD 1 trillion to over USD 2.3 trillion today[1]).  Institutional investors particularly endowment funds, pensions, sovereign wealth funds (e.g. the Future Fund) have markedly increased their use of alternatives in their portfolios. Alternative strategies (such as hedge funds and managed futures) and alternative assets (such as commodities, private equity, infrastructure and gold/precious metals) have formed an important part of that strategy.

Yet for retail investors the hedge fund has struggled to overcome negative perceptions – understandable given that hedge funds often take conflicting positions to other investors by going short on equity that they believed to be over-valued. Closer to home, a recent ASIC report[2] notes that Australian hedge funds do not pose a systemic risk to the financial system, because they have low levels of gearing and adequate liquidity.

At Select we have been investing in alternative managers since 2002 and in 2004 we launched a fund tailored to alternative investments. During this time we have learnt a lot about the asset class.

What are alternatives and what are hedge funds?

In summary, both terms are somewhat ambiguous. Alternative investments In Regulatory Guide RG240 ASIC sought to define a hedge fund but ended up categorising a large proportion of the investment industry as hedge funds!

We define a hedge fund or an alternative fund by its investment strategy – therefore avoiding broad “catch all” definitions. Typically hedge funds exhibit an alternative investment strategy. This means the main portfolio objective is to do something other than purchasing (long) equities or bonds (traditional investing).  Some examples of what we consider hedge funds are set out below.  Often the descriptions of strategies can be quite technical, so I have sought to apply how Select defines some of those strategies below.

Portfolio Construction: What are the key trends in alternatives investing?

It is now a widely held belief that investors should have some alternatives exposure either directly into a portfolio of funds or into a diversified alternatives portfolio (also known as a fund of funds).   In a recent survey McKinsey noted the growth in alternatives particularly amongst retail investors in the United States:

What should I consider before investing in alternatives?

First of all – we all know that past performance is not indicative of future returns so after a cursory glance at long term and recent performance be prepared to consider a wide range of additional due diligence issues. Advisers should consider capacity, transparency and liquidity when evaluating the appropriateness of a particular alternative strategy/asset for a client.

Capacity

Capacity is important to ensure that the manager can deliver its strategy as its assets grow.  Many strategies are niche and too many assets may indicate a successful marketing machine but not necessarily a good long term performance engine.

LESSON #1 – Objective due diligence

Previously investors has sought to chase returns or chase perceived quality.  Following the herd into an investment has proven ill-advised on many occasions.   Just because a fund is large or “exclusive”, that doesn’t make it a good investment.  Wealthy Swiss investors found this out the hard way with Bernie Madoff!

KEY CHECKS – how much have fund assets grown?  Track performance over the same period along with performance of an appropriate index… Note significant asset raising versus average performance relative to the index.

Transparency

Avoiding funds that are not open about their investment strategy is vitally important.  Many funds harbour secretive strategies behind such terms as “proprietary trading systems”. These funds are unlikely to be engaged in nefarious activity however investors should place high value on clarity of what the fund invests into. This is one easy way investors could have avoided Bernie Madoff’s fund, the biggest managed fund fraud in history, exposed in 2008.   An increasing number of fund of funds are able to look through into the holdings of the underlying managers ensuring that the additional layers do not obscure the ultimate underlying investment.

LESSON # 2 – Transparency

When I first joined the hedge fund industry in 2002 the London based firm I was working for had an investment with a US fund called Beacon Hill.  Whilst our investment team liked the principals and felt the strategy was solid, transparency within the portfolio and governance process was questionable.  We learned the hard way when the fund lost 50% of its value by doubling down losing bets and conjuring up a false unit price.  After this we invested a lot in transparency and operational due diligence to check the portfolio and the unit pricing process.

KEY CHECKS – what reports are available to an investor?  Do you get a breakdown of the entire underlying portfolio? Also ask for the Fund’s audit report.  Does the report show the underlying assets – if not ask why!

Liquidity

Despite the rapid recovery of the industry, the growth of alternatives has actually been held back by many funds lacking the ability to provide desired investor liquidity.  In a recent report “Rise of Liquid Alternatives Survey” Citigroup sees global demand for liquid alternatives from the retail audience reaching $US939Bllion by 2017 and $US1.3Trillion including institutions seeking greater liquidity. They note that this would make the liquid alternatives market nearly as big as the entire hedge fund industry at the end of 2008.

LESSON # 3 – Underlying Liquidity

Many hedge funds began investing in private equity assets in 2006 and 2007.  When liquidity dried up in the markets (there were no buyers), these assets became impossible to sell.  Some pension funds still have these assets on their books.

KEY CHECKS – Does a multi-manager have significant look through to the underlying assets? What liquidity does the fund offer?  Can an independent risk manager prevent the sale of illiquid assets?

What about Fees?

Trends from the United States indicate that fee levels in alternative strategies are reducing – or improving for investors. However investors should carefully review all fees – particularly performance fee structures – that may contain surprises for the unwary. However it is our experience that many hedge funds targeted at US retail investors are now offering structures with no performance fees at all.

For retail investors, unless they are investing through a fund of funds, the choice of alternatives will be limited to those that can offer their products in Australia. This limits the investment universe for retail investors, with many preferring the fund of funds route to gain access to institutional quality managers offshore. The Australian alternatives markets can limit the strategies available particularly in an increasingly global world.

KEY CHECKS – how does the performance fee work? Does it apply to unit holders as a whole or each individual investor?  If the fees seem low – ask why.  Are they being hidden by a swap or similar arrangement?

Summary

The alternative investment industry has evolved substantially since the lows of the GFC and many believe they offer substantial benefits to a diversified portfolio.  The industry must however be able to deliver capacity, transparency and liquidity along with cheaper fees to match the goals of retail investors in Australia.  At Select we believe that change is happening.  Global investors (including the bellwether of US retail investors) are steadily increasing the use of alternatives in their portfolios, as they also believe better conditions prevail to ensure lessons have been learnt since 2008.

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Select strengthens its partnership MGD Wealth.

The Select Asset Management Limited group (Select) and MGD Wealth Limited (MGD Wealth) have strengthened their partnership after the addition of a third portfolio, the LDI Connect 20 Portfolio, and achieving the milestone of $100m in total funds under management for the LDI Connect Portfolios, with the first 2 LDI Connect Portfolios, LDI Connect 3 and LDI Connect 7, having been launched in January 2012.

Select Fund Services is the responsible entity for the LDI Connect Portfolios while Select Investment Partners provides implemented portfolio services to MGD Wealth, the investment manager of the LDI Connect Portfolios through its Customised Portfolio Solutions (CPS).

Stephen Furness, Director and Head of Investment Advisory of MGD Wealth, said, “The launch of LDI Connect 20 to provide cash reserves to meet longer term liabilities than envisaged with LDI Connect 3 and 7 and along with the growth of the LDI Portfolios to over $100m in less than 2 years demonstrates the benefit of working with an experienced implemented portfolio consultant such as the Select group where they provide an “end to end” solution. It allows non-institutionally aligned wealth management businesses such as MGD Wealth to compete with the vertically integrated advisory businesses, adding value to our shareholders but more importantly to our clients by aligning them with our Liability Driven Investment process.”

David Yale, Executive Officer and Head of CPS for Select, said, “As with all of our CPS partners, we have structured the LDI Connect Portfolios so that MGD Wealth can offer their clients customised portfolios under their own brand and on their preferred administration platforms, that they control as investment manager, with Select Investment Partners providing them asset consulting and implemented portfolio services.”
The launch of MGD Wealth’s LDI Connect 20 Portfolio added to the earlier releases this year of CPS portfolios by DMG Financial Planning Pty Limited and Stonehouse Financial Services Pty Limited, advised by Select Investment Partners.

Mr Yale said, “We are currently in discussions with a number of other non-aligned dealer groups who are also looking for a new source of valuable and FoFA compliant revenue and/or extensive back office efficiencies with an institutional portfolio management capability that allows them to meet the best interest tests for their clients.” He said, “All of these potential CPS partners are looking for value and differentiation in their investment options for their clients beyond the use of a standard model portfolio implemented inefficiently by individual advisers.”

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It begs the question: in today’s highly regulated world post FoFA, how well do you really know your fund manager? Do you fully understand risk as it pertains to doing business with any particular funds management outfit? Should you even care?

Alex Wise from specialist fund manager Select Asset Management continues his second of a four part CPD mini-series with an insider’s account to better understand what goes on to determine the key (non-investment) risks in funds management. (Click here to read the first article in this CPD series).

Business Risk Due Diligence is an important part of any allocation decision.  The main drivers are always likely to be forward looking views of strategy and manager performance, however since a number of high profile investor frauds such as Trio in Australia and the Bernie Madoff affair in the United States, greater scrutiny has been placed on operational and business due diligence globally. It should be made clear that whilst thorough Business Risk Due Diligence should assist in uncovering concerns and inconsistencies, it is not a fool proof method of uncovering any highly sophisticated fraud.   However, several ‘red flags’ – common to the Trio case and the Madoff fraud should have put investors on notice.

A thorough Business Risk Due Diligence review will consider the risk of a catastrophic event or, in crude terms a “blow up”. Effective due diligence provides a much broader insight into the overall quality of each manager’s business, including the firm’s culture and operational philosophy. Indeed, “business risk” due diligence is probably a more helpful description than a more limited “operational” due diligence framework.

It is important to consider both Business Risk Due Diligence and investment research, when making an investment.  Whilst it is important to differentiate between these disciplines there are clearly multiple points of overlap that exist.

The Manager

Many investors believe that larger managers rank lower on the operational risk scale and are thus relative ‘safe havens’.  Whilst it widely believed that smaller boutique managers tend to be exposed to greater operational risk it is also true that larger managers often have complicated business models and may exhibit significant operational risks.  Larger investors may have “deep pockets” and resources but many investors believe the outperformance or ‘alpha’ is higher in smaller, more nimble managers.  Operational processes do vary within the asset management industry and investors need to do their homework on a particular manager and fund before investing.

Investors should consider whether there has been appropriate investment in people, systems and other infrastructure. After analysis, investors have a good indicator of whether the manager is investing in infrastructure for the long haul or treating the management vehicle as a “cash cow”.

Business Risk Due Diligence should include a review of the manager’s personnel.  The manager’s team of people is important not only in implementing investment strategy but also in supporting that implementation through operations.  Some fundamental questions that should be asked include:

• are the managers significantly experienced to run the strategy?
•  are business support staff appropriately qualified in accounting or law?  (A good test is to review the qualifications of the key staff and where possible take references.  I have seen some underwhelming qualified people acting as “Chief Compliance Officers” and even an electrician sitting on an offshore fund board!

Segregation of duties is important and high level Business Risk Due Diligence should uncover the roles of the portfolio manager and the COO or back office manager.

Technology is increasingly available and affordable, and as such any review should include some review of the manager’s technology platform.  In my experience technology and business continuity plans of fund managers in Australia often exhibit weaknesses for example in appropriate server security or untested business continuity plans.

We have noted far deeper adaptation of cloud based technologies in overseas fund managers and expect this trend to continue into Australia.  Users of the cloud should have significant redundancy in internet connectivity in place with multiple ultra-fast internet connections.

The back office functions are clearly important in any fund manager but often overlooked or treated as mundane.  Trade reconciliation, settlement monitoring and valuation are hugely important areas.  Failed trades represent a risk not only to the manager but also to the fund and its investors.  Furthermore valuation errors can have a significant impact on net asset values or “NAV”s.

In respect of compliance, investors are looking for a compliance culture.  This doesn’t mean a business has to be bogged down in red tape: in fact an easily applicable set of rules is more appropriate for a smaller manager than a 200 page document that nobody reads.  In terms of personnel a seasoned compliance officer and an experienced, independent compliance committee provide a solid base from which a compliance culture can grow.

The Fund

Most investments are carried out through fund structures.  In Australia these are unit trusts and elsewhere these are typically companies or partnerships.  No matter what the structure funds are legal entities and governed by a set of constitutional rules and offering documents.  Whilst these documents contain powers, discretions and authorities they are low on practical content.  A Product Disclosure Statement for example contains limited practical information other than perhaps the fees (unless they are hidden through swaps) or timeframes for redemptions and subscriptions.

A PDS does not typically include some important information, for example who calculates the fund’s unit price or the identity of the custodian and auditor..  These are material issues and investors should ask questions to ensure sufficiently qualified and rated counterparties are involved. I have seen examples where affiliates of the manager are used in various roles without adequate disclosure. Additionally we would prefer accounting firms with dedicated financial services practises to be carrying out the audit.   There are still many managers who prefer to hire lesser known auditors effectively “doing things on the cheap”.

Practical investment terms of redemption and subscription should be carefully reviewed.  It is also important to match the redemption terms of the fund with the liquidity of the underlying investments.  For example, if a fund holding illiquid credit or property offers daily liquidity investors should consider what will happen if unitholders stampede for the door in significant numbers?    Investors should understand the ‘gating’ powers.   During the GFC investors were left holding illiquid investments for significant periods of time – often with managers and “responsible” entities charging substantial fees during those periods.

The fund structure offers significant opportunity for managers to align their interest with investors.  Investors should want to know the answer to one simple question “how much money does the portfolio manager have invested in the fund?” Few diners eat at a restaurant where the chef refuses to eat his own cooking.  In our experience this is a question that largely goes unasked and unanswered by many investors and researchers.  We have also seen many examples (particularly in Australia) of high earning portfolio managers with insignificant amounts invested in the fund.  Investors can make up their own mind as to whether they think the manager has sufficient alignment with investors.

Another area for alignment is performance fees.  In essence if the manager performs he gets paid.  However it is not quite as simple as that and investors should look at high watermarks, benchmarks and equalisation. Some performance fees allow a manager to collect performance fees even where the fund’s performance is down for the year, investors can make their own judgements on whether that is fair.  Equalisation is uncommon in Australia but it effectively means an investor pays an individual performance fee from the time they invest.  Due to the fact that few fund administrators in Australia have purchased systems that allow equalisation; investors can lose out in paying performance fees when the fund performance is below the level at which they invested.

To recap

Many investors and advisers are constrained by their resources but governed by a best interest duty.  Investing with a poorly organised manager with inequitable fund terms, liquidity mismatch and a weak auditor are unlikely to be in the client’s best interest.  Investors should also have some method of concentrating resources only on the highest risk managers.

Business Risk Due Diligence should capture the operational and wider business risks; in particular what can go wrong.  Experienced investors weigh the risks of what can go wrong against the ability of the manager to make money.  Only in doing this can investors truly satisfy the best interest test.

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Alex Wise from specialist fund manager Select Asset Management begins this first of a three part CPD mini-series with an insider’s account of making the most of your BDM visit.

Manager meetings can be daunting.  The range of subject matter can be complex, and quantitative statistics difficult to, well, quantify.  Many advisers are also meeting with business development managers (BDMs) who have no involvement in the portfolio management of the fund in question.  The key for meeting preparation is the right mindset: “How am I going to get the best out of this meeting”.

Firstly, what’s going on at such meetings? From the point of view of the BDM entering the meeting there are competing objectives of education and sales.  The BDM is looking to educate the audience about the fund manager and fund in question with an eye to making a sale (whether it is a new investment, increase to existing positions or persuading you to keep your position in a certain fund).  Your job as the interviewer is to carry out or add to your existing knowledge of the fund manager; in essence carrying out due diligence.

The result of the due diligence effectively means an adviser makes a decision whether to allow the fund manager the privilege of managing his or her client’s money.

In order to make that important decision the adviser should be looking at some very simple but vital considerations:

• Can I make a judgement regarding the manager’s honesty?
• Do I think the Fund Manager’s organisation is competent?
• Does the investment strategy have the potential to make money going forward?

Preparation

Prior to the meeting an adviser should receive information regarding the fund.  This could include the latest monthly report, possibly a presentation, an FSC or AIMA Due Diligence Questionnaire (DDQ)  and the Product Disclosure Statement (PDS).  Take more than a cursory glance at these ahead of the meeting, as they represent a wealth of information about the fund manager in question.

The PDS carries (or should carry) functional information such as “when can I subscribe or redeem” and “what are the fees”.  The rest of the PDS is largely boiler plate language and it is difficult to learn about the Fund’s investment strategy from this document alone.   Typically you might also expect wide-ranging language regarding the risks of the fund.  This language is not really for education purposes more to protect the fund manager and issuer should things go wrong!

Fund performance in focus

In relation to the monthly report take a look at past performance.  Are there any periods where the fund has performed well or poorly?  If the fund has performed well in difficult market environments then the adviser should prepare questions on these areas.  Conversely if the fund has underperformed in bull markets this should be analysed too.

The Due Diligence Questionnaire is a very important document.  When reading the PDS an adviser should note down any questions – particularly in areas that are not easily understandable.

It’s also worth making time to carry out some basic desk research via the web.  The internet is a wealth of information and as a first port of call can often uncover some hidden gems of information.

Take the time to call industry peers to take an informal reference on a new manager, particularly if you can find someone who has invested with the manager previously.  Find out what their experience as an investor was like, aside from whether the manager made or lost them money.

Once your preparation is done review your questions and notes with a colleague – perhaps they might have met the manager previously and may have some insights too.

The Meeting

A trait of human nature is the suppression of natural inquisitiveness primarily because we don’t want to appear ill-informed.  The research meeting is not the time to worry about asking the ‘dumb’ questions!  In fact, often what may seem to be a ‘dumb’ question is the best one to ask – and the hardest to answer.  Even seasoned advisers start with entry level questions and many rely on instinct as a guide throughout the process.

A good starting point is to ask the BDM to explain the investment strategy.  If you are confounded by buzz words and fund manager-speak don’t be afraid to ask “What does that really mean?”  There are some cases where the BDM doesn’t really understand what they are selling, particularly if it’s a complex strategy, for example a Cumulative Translation Adjustment (CTA).  If a BDM cannot explain a strategy to you with sufficient clarity then you are perfectly at liberty to ask for someone else who can explain the strategy.   Most institutional investors will meet directly with the portfolio manager (PM) with sufficient frequency.  Ask for a follow up meeting or call with the PM so that they can explain the strategy directly.

Ask about the manager’s investment philosophy and then ask about the investment approach.  Note details on the various stages of the investment process to assist future readers.  Ask for details on portfolio construction and risk management.  This process can be quite complex so the BDM will have to explain it with sufficient clarity.

It also helps to ask for examples, particularly if you are in deep technical conversation regarding, say, the risk management focus on the fund’s ‘sell’ criteria.  It is also very helpful to ask about the fund’s expected behaviour; this can of course be monitored.  When looking at risk management be sure to ask about whether this is independent from portfolio management.  The segregation of these duties is fundamental in any funds management business.

As you work through the list of questions prepared ahead of the meeting make additional notes about follow-up points.  Recap these at the end of the meeting to ensure the BDM knows exactly what your requirements are to move forward to the next stage.

It’s good to note why the fund was set up as this usually leads to a discussion about what ‘edge’ the fund brings and how the manager thinks about the market.

The Meeting Note

The meeting note is a crucial document for your risk management.  The note should be comprehensive enough to show the key points of the meeting yet succinct enough to be read by future users.  The Meeting Note should distil the meeting discussion right down to the key points of the discussion.  The Meeting Note is also a good forum to include text about why (or why not) this particular investment is in the best interest of clients.

The Meeting Note should also summarise the key facts from the meeting.  What is the Managers Funds under Management? How long has it managed money? Who are the PM’s for the fund?

The Meeting note should be differentiated from the Due Diligence Report which should include a call to action “Buy/Sell/Watch” and conclusions on why this investment is in the best interest of the client.

The meeting note should not allow the writer to sit on the fence – it should include information on what the author really thinks!

Once the meeting note is complete it can form part of your due diligence pack on a particular investment.

The Due Diligence Pack

The Due Diligence (DD) Report or Pack should include all information provided by the manager as well as the notes from any meetings held.  These packs are often presented to investment committees.

If you are writing a report about a fund in a relatively new or complex area you may like to insert a section describing the market/strategy so that the reader has enough background knowledge to properly consider the rest of the report.  Try to keep it as concise as possible. Try to not just cut-and-paste from a DDQ as manager prose can often be generic and unlikely to satisfy the best interest test.

Reflect on your notes on the investment process then focus on your opinion of the investment process.  Note what you think are the strengths and weaknesses?  Does it reflect the investment philosophy?  Does it exploit the manager’s edge?  Do you think it leads to any bias?

The DD Report should recap on the meeting notes (there may be multiple).  Some key areas to cover are performance, risk management, liquidity and structure.

Meeting with managers and conducting due diligence requires a significant investment of resources – particularly in a capacity constrained business. Many advisers use a consultant to assist them wade through the tasks.

Above all, however, an adviser should be confident the investment is in the best interest of her of his investors: do not be afraid to walk away from a manager on nothing other than gut feel.

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Alex Wise

With the Future of Financial Advice (FoFA) kick-off date of 1 July looming, specialist investment management group Select Asset Management Limited (Select) has urged Australian financial advice firms to have a hard look at underlying investment structures used to manage client portfolios.

“A prevailing sentiment is that FoFA has been a hard slog, with little business upside for planners beyond the implementation date,” said Select Fund Services Head Alex Wise.

“But our experience with a number of financial advice firms is that FoFA has provided a catalyst for positive benefits, beginning with managing the key issues of business risk,” he said.

Mr Wise said that while many financial advice firms are still wrestling with conflicted remuneration and the best interest tests introduced by FoFA, others are seeing operational efficiencies and investment benefits deriving from their solutions.

“Financial advice firms that have found solutions to their FoFA compliance issues are also discovering significant efficiencies and FoFA compliance benefits in operating multi-asset portfolios through regulated unit trust schemes,” he said.

“On the investment side, customised portfolios in a fund structure provide unlimited access to diverse Australian and global investment managers and can invest globally incorporating risk reduction techniques such as foreign currency hedging very efficiently. These unique portfolio construction characteristics have proven beneficial in current markets.”

“Additionally, structuring customised portfolios in this manner has increasing relevance in meeting the best interest test and avoiding the conflicted remuneration obligations under FoFA.”

Recent examples include portfolios operated by Select Fund Services investing in offshore structures that effectively provide insurance in the event of market volatility.

“Select has provided funds with tail-risk hedging that is not easily available through wrap or MDA accounts. One example would be a Japanese focused fund that has provided significant out-performance as Japanese government bond yields have spiked.” said Mr Wise.

Mr Wise said the use of such an approach builds a robust underpinning in the core operational areas of risk, secure custodial arrangements and professionally managed portfolio construction services.

Select Fund Services provides responsible entity (RE) services to numerous dealer group clients. This service enables licensees to focus on investment management and advice – giving Select Fund Services the job of compliance, governance and fund administration.

“Select Fund Services operates 20 funds as RE and trustee for multiple clients. Our systems and processes are tailored to provide fiduciary oversight to multi-asset portfolios.”

In addition to pure governance and compliance functions, Select Fund Services also delivers services to multi-asset unit trust structures. “Select has significant experience in drafting product disclosure statements for these types of portfolios and can also provide expertise to assist with important marketing documents.” said Mr Wise.

Multi-asset managers using a unitised registered scheme also gain the benefit of investor protection mechanisms such as an independent custodian and auditor. “Select has hand-picked tier 1 providers such as Ernst & Young for audit, Baker McKenzie for legal advice and BNP Paribas for the custodial function. This completes a fully institutional offering for our customised portfolio clients”.

Additionally, non-aligned dealer groups and planners have also found a significant operational burden in rebalancing fund investments ‘off-wrap’. This particular challenge has been met by Select Fund Services to engineer an easy outcome.

ASIC’s recent consultation paper on risk management CP204 indicates higher regulatory oversight for the way RE’s address business risk. Coupled with increased scrutiny of MDA operators and their capital adequacy, this has made it difficult for some firms to establish schemes internally.

“From a compliance perspective we also run significant risk management overlays, this clearly being the way ASIC would like RE’s to go and we are ahead of the curve on this,” Mr Wise said.

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This is the view of specialist investment management group Select Asset Management (Select) which says higher consumer protection standards, including the onerous ‘best interest duty’ that applies to all product recommendations beyond 1 July 2013, has raised the bar for how financial planning licensees manage their risk of falling short of new requirements.
 
David Yale, Chief Risk Officer with Select, says the new regime fundamentally alters the operating landscape, especially for those groups running in-house portfolio construction and investment product models.
 
“We see an emerging world where non-aligned advisers will seek to maintain greater control of client relationship and outcomes, but also limit downside business risk as it relates to complying with the new standards.”
 
“So, there is a high degree of tension between those two ends of the advice business spectrum, particularly as the deadline for FoFA compliance begins officially on July 1,” he said.
 
What operational risk?
 
Select says advisers and licensees must have effective ways to equip their business against the risk of failing the best interest duty under FoFA. “I believe there are a number of aspects to this”, said David Yale. His top three issues for advisers to consider, under best interest, include:
 
1: Comprehensive research capability
 
Advisers will need to illustrate why each investment exists in the client portfolio. In other words: why is this asset in this portfolio, and why have certain other investments been excluded? There is a need to be across exactly what investments have been selected and why, and this needs comprehensive market and investment research expertise.
 
Mr Yale added, “There is a need for ongoing econometric and macro analysis to monitor market conditions and maintain an informed asset allocation view at all times.”
 
2: Real-time portfolio adjustment
 
Mr Yale said advisers would also need to consider how they keep client positions consistent with this overarching asset allocation view over time, requiring the capability to make timely, ideally real-time, portfolio adjustments.
 
3: Scenario analysis
 
Further compounding the complexity of best interest, Mr Yale said advisers should be equipped to respond to specific questions such as: ‘Why is a portfolio expected to meet its objectives?’ And ‘How might the client’s capital be protected in difficult markets?’
 
“Such analysis requires the application of sophisticated scenario analysis and stress testing techniques,” Mr Yale said.
 
“And sitting across all of this is a requirement for risk management capability that efficiently identifies, monitors and manages key risks and any unexpected investment behaviour.”
 
Mr Yale said the potentially onerous requirements of the new standards, such as the best interest test, had led certain dealer groups to find a better solution that primarily ticked three boxes: improved client engagement; FoFA compliant investment recommendations; and genuinely addressing the best interest principle.
 
“Various non-aligned financial planning licensees and dealer groups have met with Select to discuss their concerns, seeking ways to better handle the challenge of delivering excellent portfolio construction outcomes for their clients, whilst achieving compliance with the FoFA legislation.”
 
“We have developed an outsourced model, called Customised Portfolio Solutions or CPS, which is a bespoke model built to help these groups such as Profile, MGD Wealth, Stonehouse and DMG find a better, compliant, risk-mitigated way to run client portfolios.”
 
“The Select CPS service comprehensively equips dealer groups and advisers to deal with the operational and business risks presented by FoFA. In effect, the solution gives advisers the benefits of an investment management business but without the overheads or conflict – so enabling them to tick the best interest box knowing they genuinely comply with this upcoming and potentially onerous obligation.”

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Select has secured partnership agreements with several leading financial advisory firms and expects many more non-institutionally aligned licensees to be interested in its CPS. Gippsland, Victoria-based DMG Financial Planning Pty Limited* (DMG) has become the most recent firm to sign on for Select’s CPS.
 
Select Fund Services will be responsible entity to the DMG Diversified Portfolio, while Select Investment Partners will act as DMG’s asset consultant. 
 
The DMG announcement follows the launch of the Stonehouse Core Value Portfolio in February 2013.  Select’s CPS have also been in use by Profile Financial Services and MGD Wealth for over 2 years and 1 year respectively. 
 
Select CEO Brendan Foley said: “Select has pioneered a unique portfolio service built on our decade-long track record of investment management and administration excellence. Not only that, we are offering financial planning licensees a way to build viable business propositions based on the most scrupulous ‘best interest’ principles.”
 
Mr Foley said such non-institutionally aligned groups are also seeking greater business certainty built on non-conflicted remuneration structures and a systematic approach to enhancing the full value proposition of unfettered financial advice.
 
“Demand has increased as we approach the July 1 start date for FoFA reforms, with many quality dealer groups seeking innovative ways not only to remove or minimise their compliance risk, but to properly unshackle their advice from the constraints of inherent conflict.”
 
Mr Foley said such licensees have had too few choices as they seek a non-conflicted approach and to avoid the pitfalls of institutional dealer group models where research, investment and platforms are tilted towards in-house investment products, further complicated by being built on vested research ratings.
 
“Standard model portfolios and recycling approved product lists no longer makes the grade,” he said.
 
Mr Foley said advisers are attracted to Select’s dual offering and track record: “We understand how to successfully manage non-conflicted multi-asset investment portfolios, and have done so on behalf of ourselves and third parties for over a decade. We also have deep experience in operating retail and wholesale funds (administration, compliance) through the Select Fund Services business.” 
 
Each of Select’s growing list of financial planning partnerships – those that strongly value moving towards independence from institutional influence – demonstrate how to turn the challenges of FoFA into long term-growth opportunities.

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The firm has also announced a foundation alliance with Australian specialist investment management firm Select Asset Management.

Winston is led by founding partners Stephen Robertson, Nathan Wares and Andrew Fairweather. The management team brings to market a unique combination of world class financial services marketing and distribution expertise, together with seasoned funds management experience honed over a combined 60+ years.

The firm will build its presence in the Australian market based on four key pillars: funds formation, third party distribution, capital raising and specialist advisory.

“Winston fills a gap in the Australian investment management market for professional distribution, capital raising and advice services which, at their core, link best in class domestic and offshore fund managers to philosophically aligned investors,” said Winston Founding Partner, Stephen Robertson.

“Kindred to these services, Winston will also develop specialist asset management product lines which will target the growing demand for innovative alpha generation and investment capability in Australia,” Mr Fairweather said.

 Winston understands that many investment managers seek to focus on their core activity of managing investments.

By partnering with Winston, managers can focus on their passion knowing their capability is professionally delivered to investors that place a greater reliance on working with a trusted funds management provider. For international fund managers, Winston would undertake the often complex market entry tasks. By partnering with Winston, offshore managers will enjoy a successful and risk mitigated experience across the spectrum of investment and fiduciary requirements, regulatory obligations and investor needs.

Select Asset Management
Key to bringing great asset managers to investors involves assessing operational standards and the alpha generating ability of each manager or investment offer. To provide that end-to-end proposition, Winston is pleased to announce an alliance with Select Asset Management (Select).

Select brings an important element to Winston’s value proposition by providing due diligence services through its Fiduciary Service offer; manager and investment assessment through its Investment Consulting capability; and Responsible Entity and trustee services required to successfully deliver quality products to investors.

Winston and Select will now offer a complete service, covering back office, regulatory and compliance, marketing, distribution and product packaging, benefiting fund managers and investors with a convenient all-in-one solution.

Commenting on the alliance with Winston, Brendan Foley, Select’s Chief Executive Officer said: “the launch of our new product manufacturing, fiduciary and due diligence services headed by Alex Wise, combined with Winston Capital’s distribution and marketing services, delivers a compelling proposition to managers and end investors. Having also appointed Winston to represent Select in the market, ensures that our current customised portfolio solution clients will have the same level of service from Select as always. Select will also have the ability to look at new clients with Nathan and Stephen’s extensive network.”

Commenting on the establishment of Winston Capital Partners, founding partner Stephen Robertson said: “The future is bright for specialist service providers in our sector. Winston has made a great start, having secured two advisory roles to an infrastructure fund and international manager; and the third party distribution function with Select. We look forward to working with Select and the broader market moving forward.”

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