MLC emulates active performance

By Michael Bailey

MLC is claiming to have achieved better after-tax returns and lower transaction costs just months after introducing its unique ‘emulation’ method for running a multi-manager portfolio.

Going live last November after three years of planning, the strategy sees passive manager Vanguard Investments emulate the performance of a customised benchmark that is based on a combination of MLC’s active incumbent managers’ portfolios.

In effect, MLC provides Vanguard a fortnightly, aggregated update of what its eight active Australian equity managers are holding. The index manager simply follows this information like it would the ASX 200.

Of the $15.7 billion that MLC runs in Australian equities, which includes $2.5 billion in the popular IncomeBuilder product, Vanguard has been assigned $1.5 billion for the ‘emulation’ mandate.

According to MLC head of asset management Michael Clancy, having one manager partially do the work of eight stops a lot of costly anomalies within a multi-manager portfolio.

“The win for MLC’s investors and their advisers is that they pay less of the brokerage and custody fees created when one of our managers buys a stock and another sells it on the same day,” he said.

Vanguard is also managing all the cashflow into and out of the Australian equity portfolio, which Clancy said was minimising disruption to the active managers and allowing them to better focus on their stockpicking ideas.

Clancy added that ‘emulation’ was already producing lower overall turnover in the Australian equity portfolio, leading to less incidence of realised capital gains — particularly important now that twice the capital gains tax is payable on shares held for less than one year.

“How many times have you heard a portfolio manager in this country mention after-tax returns? Not often. The tax bill of a managed fund is often many times higher than the management expense ratio, but no one talks about it,” Clancy said.

“MLC has always had a sharp focus on the tax efficiency of its investments, and ‘emulation’ is another example of us striving for better after-tax returns. Everyone in Australia is a taxable investor, after all.”

Clancy said after three months it was too early to extrapolate how much turnover could be reduced long-term under the ‘emulation’ model.

He did confirm, however, that the addition of Vanguard had so far added nothing to the overall tracking error of MLC’s Australian equity portfolios, a fact which has appealed to Lonsec senior researcher, Grant Kennaway.

“In a conventional multi-manager portfolio, there’s only so many managers you can add before the thing collapses under its own weight. Emulation struck me as a less risky way of diversifying and enhancing returns, rather than just adding another active manager,” Kennaway said.

Clancy was also cagey about many of the finer details of ‘emulation’, particularly the commercial arrangements behind the deal.

“It’s not like we’re following established practice from the US or UK here. We’ve put a lot of work into ‘emulation’ and I don’t want our competitors copying it in five minutes.”

While the index manager receives what is understood to be a typical passive fee for its services, it is unknown whether MLC ends up paying its active managers less because of reduced implementation responsibilities, or whether their fees remain static, or even rise, in return for their sharing of proprietary information with an external manager.

Clancy added that the active equity managers have welcomed the opportunity to reduce their physical assets under management, particularly in Australia’s notoriously tight market.

“The win for our managers is that by getting Vanguard to manage some of their money for them, they get some of their own assets under management taken off the table. A few of our managers are approaching their capacity constraints, so it might allow them to take on a few more, smaller mandates which will probably pay them better than a big mandate from MLC.”

The important thing for advisers, according to Clancy, is that the retail management expense ratio of the Australian equities fund has not changed.