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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It’s like asking “how long is a piece of string?” without ever having seen the piece of string and unfortunately can show a lack of understanding by the adviser on the behind the scenes advice process. Similarly, a simple answer of “about 4 hours” by a paraplanner in an interview can show a lack of understanding of the various factors that go into the preparation and completion of a Statement of Advice.

To answer this question, we asked the members of Paraplanning Network Australia for their insights into “the key factors that impact the time it takes to generate Statements of Advice,”  Some of these insights follow:

1. It’s all about the integrity and completeness of data – a fully completed fact find is a good place to start, but often additional information is required when it comes to research and developing recommendations for a SOA. Having a checklist to ensure you have all necessary information, obtaining an Authority to Access Information and asking clients for current investment, loan, insurance and super statements from the outset can all help to speed up the paraplanning process. 

It’s also important to consider who is responsible for obtaining any required information and consider what their workload is. How long will the task sit in their “to do” pile and add to SoA turn-around time?

2. Am I making myself clear? – Noreen Les, Senior Paraplanner at Circle Paraplanning Services  says “One of the main factors for me is the quality of advice notes and documents provided by the adviser, i.e. the level of detail they provide and the personalisation, specific to client goals and why the advice is being provided to address those goals.”

To build a strong reasonable basis and create a more personalised Statement of Advice, the adviser can assist the paraplanner greatly by providing clear and concise instructions outlining discussions with the client; their specific goals and objectives.

3. Relationship is the key – it’s important that the paraplanner understands the adviser’s preferences for style and tone of advice.

“This includes how to interpret what an adviser is saying and writing/developing these into legible recommendations in a compliant SoA… if you don’t have a good understanding with the planner, there can be a lot of time spent making changes and updates to the SoA, even doubling the time spent sometimes.” – Lindsay Ross, paraplanner and owner at Wealth Leaders Pty Ltd.

Customising standard text can be a worthwhile exercise to reduce the time spent re-writing text that the paraplanner has written.

4. Templates, templates, templates! We all know the benefits of having templates in place, however if these haven’t been reviewed for some time then these can often become more of a hindrance than help to a paraplanner, with considerable time wasted editing and re-formatting a document.

“The more complex the plan the greater the need to stray from standard text and the need to develop own wording. This can take extra time if the adviser does not concur with the style that this has been written by the paraplanner,” says Quinton Sosnowski, Technical Specialist at Managed Financial Strategy.

5. It’s complicated! – The more complex the strategy, the more time spent by the paraplanner on researching the technical aspects, legislation, ramifications and compliance requirements and analysing the cost benefit of particular strategies. In situations where multiple scenarios are considered, this then further increases the preparation work for a SOA undertaken by the paraplanner.

To assist your paraplanner with this process, ensure that you are utilising the resources available to you, are you sharing these with the paraplanner? Does the paraplanner have access to the support services of a technical team to assist in the strategy development, or have similar strategies been recommended in the past, especially where you have been comfortable with the way the strategy was presented and explained in the SoA? Assisting the paraplanner in these ways can cut down the time it takes to develop complex advice documents.

6. Have you ever considered modelling? – Projections are an integral part of the paraplanning process. If a paraplanner is not confident with the calculator or software then errors are easily made and time is easily wasted. The key to a paraplanner being able to complete modelling efficiently is mostly in the accuracy and level of data provided and how confident they are using the calculator or tool.

One tip to make the process simpler is to provide a list of default strategy, investment return and general assumptions to be used for all projections. This helps to build consistency in your projections, reduce errors and more easier identify where data has been incorrectly input.

7. How about the software? – A paraplanners lack of experience or familiarity with financial planning software can double the generation time of a SoA.  “Financial Planning software is really a paraplanners domain. They’re going to use it more than any other employee,” says Dave Perry – Director at Accurate Admin Solutions Pty Ltd.

“I think one of the biggest factors in determining the time it takes to prepare advice is how good the templates are and your ability to “feed” data into them. If they are not particularly well designed and linked to the data sections within the paraplanning tools, you spend a great deal of time editing SOA’s,” says Noreen Les.

It’s vital that your paraplanner keeps up to date with upgrades and changes to the financial planning software and that they are provided an opportunity to attend additional training to up-skill and speed up the time it takes to use the tools, modelling and template wizards.

At the end of the day, there is no one size fits all when it comes to the time it takes in preparing Statements of Advice but there are many factor that impact on timely preparation. Identifying the part in the advice process where the time lag occurs, fostering better communication with your paraplanner and reviewing your templates and standard text could all help to streamline the process, reduce turnaround time and assist in building a better quality Statement of Advice.

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This is one of the key trends that financial software innovator Decimal says highlights the immediate challenges for financial advice technology in the highly fluid, post-FOFA environment. 

“We have brought to market online tools that enable the delivery of quality, compliant advice on a large scale without increasing costs,” said Decimal Managing Director Mr Jan Kolbusz. 

“The tools are also fast. Yet, we worry about placing too much emphasis – as is a simplistic view in certain quarters – that faster SOAs are better. We know that advisers in fact find that faster is not always better, if it also means more labour, effort and input cost to ensure a proper compliance standard is met.  

“The last thing the financial advice industry needs is compromised advice outcomes on the basis that we have singularly pursued speedy SOA delivery,” Mr Kolbusz warned. 

Back-office administration expert, Mr Patrick Walford, at Marketshare Solutions, says advisers require a clearer picture of the full spectrum of advice delivery – from fact find to implementation. 

“With a system such as Decimal, an adviser can see in real-time the exact nature of the advice and the detail around the advice in the instant that the SOA has been created. Any advisory compliance and administration questions can all be dealt with, within 30 minutes of the SOA being issued. 

“This is far more efficient as it also removes the old ‘back and forth interactions’ syndrome which previously took many days to resolve,” Mr Walford said.
 
Mr Kolbusz said financial advisers are also reporting fresh challenges in an environment where pressure is mounting for more client interaction and engagement. 

“But on the other hand, the need to deliver quality advice that is 100 per cent compliant without increasing costs. Both can be achieved,” he said. 

“A robust compliance system, where at every stage of the financial advice process, compliance officers can view every interaction with the consumer in real-time, can help to reduce compliance risks and maximise the potential to deliver quality financial advice to consumers,” says Mr Jan Kolbusz.

“Be it from engagement, fact finding through to SOA production and fulfillment, compliance officers can examine the appropriateness of the advice in real-time.  With a traceable history, advisers are always audit ready.”

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