Is this the beginning of the end for managed funds?

Over the last six months a lot of major players in retail funds management have been exploring and evaluating the merits of providing retail investors access to the benefits of individually managed accounts (IMA).

In particular, a number of local players, some with strong global parentage, are currently creating and implementing plans for participation in this new wave of investing.

There is a strong view that for the retail investor, the IMA will replace the unit trust as the preferred method of accessing the benefits of managed investments. If this view becomes a reality then the face of retail funds management will be changed forever and the retail investor will be the main beneficiary.

An IMA is simply your own customised portfolio of stocks managed by a professional investor. It is your own individual portfolio where you own the investments and the portfolio manager is managing the portfolio according to the instructions that you have given them.

An IMA is nothing new; it has been available to institutional investors since time began (well, since the birth of the managed investment industry) but you needed in excess of $20 million to start one. However, in this world of high technology, the IMA is now available to retail investors with as little as $100,000.

What makes the IMA so attractive to investors? It is really quite simple. In essence, the IMA offers all the benefits of a unit trust (or managed funds as they are now commonly called) without the inherent disadvantages of a trust and pooled vehicle structure. The IMA offers the retail investor everything a pooled unit trust cannot. That is, the IMA overcomes all of the inherent weaknesses of unit trust/ pooled trusts.

A managed fund offers the investor access to professional investment management, a diversified investment portfolio, an easy to administer investment and access to investment opportunities.

However, the unit trust/pooled vehicle has some significant shortcomings, including the fact that the investor cannot tailor/customise the portfolio to suit their specific investment needs.

Also, the investor may invest in a trust that has large embedded capital gains in its net asset value — the investor cannot harvest unrealised losses to offset against realised gains.

The portfolio is also influenced by other investors entering and exiting the fund, which can impact portfolio turnover and therefore the after tax returns of investors.

Finally, the investor only receives infrequent reports on transactions and portfolio holdings

The IMA is a very attractive product with all the added value features that advisers and retail investors have been looking for. In simple terms, the investor can have the benefits of direct share ownership together with the benefits of professional management.

Up until five years ago, IMAs have been the very poor cousin to the US mutual fund industry. However, over the last five years, the growth in IMAs has outstripped growth in mutual funds and many US mutual fund players are working on their strategy to participate in IMAs.

According to the Money Institute, the compound annual growth over the last five years in IMAs has been greater than mutual funds, with assets under management in IMAs currently US$415 billion.

And according to Separate Account Solutions, a specialist technology provider in the IMA market, over the last four years IMAs have grown 30 per cent per annum with assets under management for IMAs in the US expected to reach US$1.2 trillion by 2004. Going forward, Cerulli expects growth of about 30 to 40 per cent per annum in the next three to five years.

So why are IMAs not actively distributed in Australia today?

The answer lies in the heritage of the retail funds management industry that has grown off the back of superannuation and financial planning. The unit trust/pooled vehicle is a simple scalable product for investment managers. That is, they treat all investors exactly the same regardless of their individual investment needs or tax situation and pool all the small investors into one big pool. As financial planners were historically more focused on superannuation advice, the unit trust/pooled vehicle made sense.

Therefore, we have seen the retail unit trust/pooled vehicle industry grow phenomenally, whereas the IMA product has been the domain of the institutional investor and out of reach of advisers and retail investors. In addition, the technology of the industry has supported pooled vehicles.

Now, however, investors are more focused on after tax returns. They are more sophisticated and educated as their superannuation and non super investments grow, and are looking for a customised service. Will the simple unit trust pooled vehicle meet their needs?

There are, however, a number of IMAs already available to ‘retail’ investors via some banks and stock brokers. These tend to target high-net-worth investors rather than the mass affluent. Nonetheless, they do exist but they have not gathered a lot of assets compared to managed funds. This is about to change, not via the existing IMAs but via a new series of IMA products that will hit the market over the next 18 months.

Ideally, these IMAs will offer advisers and investors the benefits mentioned above but with the added benefits of wrap accounts such as consolidated reporting, tax reporting, a range of investment portfolios managed by domestic and international managers and delivered to advisers and investors via the Internet. The scramble is now on to develop and successfully launch the appropriate product.

The IMA is a product where design and technology go hand in hand, and seeking first mover advantage may see a lot of players quickly launching a product only to later find it doesn’t deliver what investors and advisers want. The key will be successfully combining manufacture, distribution, administration and wrapping of products with technological requirements. But the costs are significant, so speed to market may not be the prudent strategy.

If an IMA service can be created and delivered that offers the benefits of a managed fund, overcomes the inherent deficiencies of a managed fund and is easy to use for the adviser and investor, then move over unit trusts and make way for a better way of investing.

To achieve this will require co-operation between distribution, manufacture and competitors. There are signs of very strong co-operation and growth in the US.

As for Australia, only the future will tell, but remember that 10 years ago, a few retail fund managers believed that master funds would not last.

If the investor benefits, the adviser is able to add value in their advice and it is scalable to the manufacturer, then it’s a matter of when, not if, the IMA will change the face of retail funds management.

Stephen Robertson is head of retail,Citigroup Asset Management.