Master trust time bomb

Australia's master trusts and wrap accounts are about to undergo a massive shake-up which will leave only five left standing.

Australia's master trusts and wrap accounts are about to undergo a massive shake-up which will leave only five left standing.

A study by US-based research house Cerulli Associates predicts only five master trust and wrap providers (or portfolio administrators) will survive a round of price wars and industry consolidation.

This startling prediction is one of the key findings of a wide ranging report which is the result of 12 months studying the retail financial services in Aus-tralia.

Cerulli predicts competitive forces will cut master trust and wrap fees in half. Margin pressures will then ensure that only the fittest survive.

The group argues that a series of factors will combine to wreak havoc among mas-ter trusts and wrap providers.

"These catalysts include an industry-wide search for simplified managed fund ad-ministrative systems; an increasing inability for distribution platforms to dif-ferentiate themselves from one another; and the growing popularity of custodial wrap programs, which provide turnkey record keeping and administration at much lower cost," the report says.

The groups that will emerge as the winners will be those that innovate and capi-talise on emerging trends in the retail financial services industry. But the re-wards for these groups will be immense. In fact, Cerulli predicts that the ma-jority of money will be invested via wraps and master trusts once the fees come down. At the moment, just over a third of retail investments are made via port-folio administration services.

But this trend won't cool down the current boom in the retail financial services industry. Cerulli estimates Australia's retail funds management market has $235 billion under management, just under 40 per cent of the total funds management industry. The group reckons retail funds under management will increase to $600 billion in five years time, constituting up to 60 per cent of the market. This takes into account a growth rate of 20 per cent annually which Cerulli says is "conservative".

One of the key trends that will drive much of the changes in the master trust and wrap part of the market is the growing importance of what Cerulli calls the "employee-owned independent financial advisers" which will become "Australia's fastest-growing managed fund distribution channel".

Cerulli predicts that a growing number of advisers will abandon their ties with dealers owned by financial services behemoths and opt for dealers that allow them to take a stake in the business. Groups such as Associated Planners, Count Wealth Accountants and Professional Investment Services are examples of this trend. In fact, these groups already make up 16 per cent of Australia's finan-cial planning industry but control a disproportionately high 28 per cent of funds under administration. Cerulli expects employee-owned groups will account for 39 per cent of funds under administration by 2004. Despite recent merger and acquisition activity among Australia's financial planning dealerships, Cerulli predicts dealer groups affiliated with fund managers will suffer attrition in both adviser numbers and market share of funds under administration.

An implication of the increasing independence of financial planners will show up in the way planners are paid. Cerulli estimates both up-front and trail commis-sions are on the way out to be replaced by a fee based on a clients funds under administration.

"Cerulli's proprietary survey of Australian financial planners supports this ar-gument, showing that FPs throughout Australia are raising their portfolio review fees," the report says.

Financial planners may have more control over their destiny in the years ahead but they will have to grapple with an increasingly diverse client base. Cerulli says planners must be able to provide different levels of advice for different clients. This will become even more noticeable in a choice of funds environment and as Internet distribution continues to pick up pace. Advisers will need to respond by setting up systems that will allow them to service people who only want to buy managed funds through the adviser but who may come back later once they have amassed a substantial investment portfolio.

While fund managers might be feeling the pain in their loss of exposure to the financial planning industry, the next five years looks rosy. Cerulli predicts 20 per cent annual growth for the industry with very little pressure on margins. Management expense ratios (MERs) may fall in the next five years, but not nearly as much as some of the doomsayers in the industry would have it. Cerulli puts a 10 per cent ceiling on a fall in MERs but at the same time warns fund managers that increasing numbers of investors will buy their funds via a master trust or wrap so they will only be able to charge a wholesale fee on the product.

While there may be little pressure on margins, the kind of products demanded by investors will change radically. Cerulli says the current success of sector funds such as technology funds will continue at an ever increasing rate.

"Sector-specific managed funds will represent a greater proportion of Australian retail fund universe," the report says.

"Managers will respond to US market entrants' very specialised products with Australian dollar-denominated products of their own, adding to sector-specific product proliferation.

"Financial planners will further encourage the trend by creating portfolios of sector-specific products, thus justifying their advisory fees."

Fund managers will also compete more on performance rather than brand. Cerulli reckons this will make the going easier for smaller players in the funds manage-ment industry, especially boutique fund managers.

"Performance differentiation will take greater hold in the Australian market-place, allowing firms with less familiar brand names to still attract signifi-cant attention," the report says.

"The number and market share of boutique fund managers will increase in Austra-lia, as it is throughout the world. Portfolio managers will increasingly demand equity as part of their compensation."

Cerulli's study is the result of interviews with senior fund management execu-tives, regulators, data vendors and industry experts in Australia. CA also in-cludes results from its extensive proprietary survey of Australian financial planners.

BREAK-OUT

The new face of retail financial services

Cerulli's key findings

1. Australia's retail funds management industry has $235 billion under manage-ment, making up 40 per cent of the funds management industry. Cerulli believes this will increase to 50 per cent or $600 billion by 2004.

2. Cerulli estimates the retail funds management industry will grow 20 per cent per annum until 2004 - and they say this is conservative estimation.

3. Only five master trusts and wrap accounts will survive a tumultuous couple of years.

4. The majority of retail investments will be made via master trusts and wrap accounts once fees diminish up from 37 per cent now.

5. Australia is the most sophisticated market outside of the US and shares many of its characteristics.

6. True fee for service will continue to grow and commissions (both up-front and trail) will continue to diminish. Portfolio review fees are already on the rise in Australia.

7. Direct distribution of managed funds will rise in Australia but will not ex-ceed 10 per cent of the market.

8. MERs will only fall by 10 per cent in the next five years.

9. Advisers will abandon dealer groups owned by Australia's financail services behemoths, favouring independently owned dealers which give advisers the oppor-tunity to take a stake in the operation.

10. Overseas fund managers will enter the Australian market to sell interna-tional funds. Investment in international funds will increase from $19 billion bow to $50 billion by 2004.