SMAs set to undermine master trusts

As interest continues to build in Australia for separately managed accounts (SMAs), the extent of the impact that these tailored equity vehicles will have on master trusts remains unclear.

Master trusts have been the subject of much industry scrutiny over their cost structures and ability to hide costs in a myriad of fees and charges that even investment professionals cannot understand.

Master trust disadvantages include the inability for individual investors to trade-off unrealised losses and to offset against realised capital gains implications, as well as the impact other investors’ movements in and out of the portfolio can have on the tax liability of the individual investor.

Meanwhile SMAs, which are slated to make their debut in Australia in July, offer high-net-worth investors a tailored equities portfolio without the disadvantages of a trust and pooled vehicle structure.

Fees for SMAs are typically flat charges, which cover fees for advice, administration and investment management, while still offering bundled consolidated reporting solutions. Importantly, SMA fees are completely transparent.

It is SMA’s fee structure that is causing some people in the industry to say SMAs could add weight behind the push to reduce master trust fees.

“I do not think that [SMAs] will compete with master trusts and wraps on a fee basis,” Citigroup Asset Management head of retail Stephen Robertson says.

“But SMAs will undermine that structure. That’s what we’re seeing in the US.”

According to figures from the US, SMAs are growing at 30 per cent per annum and represent a $1 billion plus business. US-based independent research company Forresters estimates that by 2005, 25 per cent of US investors will be using SMAs.

To date, the two largest world markets for SMAs are the US and Canada, with Italy and England leading the demand for them in Europe.

With the recent announcement by Asgard of its intention to launch SMAs into the Australian market by the end of July this year, attention has now turned to the likely impacts they will have on the cost structure of managed fund investments in Australia.

Sealcorp director of distribution and sales Dan Powell says while the absorption by the US market of SMAs will not necessarily be the experience in Australia, he considers a 15 per cent penetration to be quite possible.

“We believe these funds will fundamentally change the industry in the next four to five years,” he says.

Powell says when SMAs were first launched in the US, their fees were around 2.5 to three per cent per annum, with this slowly dropping as more investors became involved.

In Australia, Powell says SMAs are likely to be launched at a fee of around 2.5 per cent, slightly more expensive than the average master trust, which he estimates to be around two per cent per annum. He says this expense is due to the very intensive management style of SMAs and the difficulties associated with administering many individual portfolios compared to a pooling vehicle such as a unit trust.

Powell says while asset managers will be able to sell SMAs direct, platforms are likely to be effective distributors of SMAs given their administration and choice benefits. However, IDPS-like structures rather than custody-based master trusts are likely to be the distributors of SMAs because of their greater flexibility in catering for investors with individually tailored portfolios.

According to AM Corporation Adviser Services group general manager Graham Davison, it is unlikely that the arrival of SMAs in the Australian market will have a big impact on master trust fees because of price premiums.

“If people are prepared to pay the price, then they will pay it. If not, then free market forces will determine whether [SMAs] will live or die,” he says.

Further, with very little movement in master trust fees over the past five years, he says it is unlikely that SMAs are going to trigger a huge fall in fees.

Davison views SMAs as the next level of development in retail financial services, however, he says somewhere inside these structures administration has to be provided.

“Who is going to pay for setting up the administration?” he says.

While Davison acknowledges that some master trusts are expensive, he says when this decision is made at the adviser or client level, a two per cent per annum fee probably does represent value for what they get.

“It could drop by a full per cent, but you would lose some other things that deliver the service,” he says.

Citigroup’s Robertson says over the next 12 months, a number of SMA products will appear because the technology is available to create them and because of the major inefficiencies of master trusts.

In this category, Robertson includes the tax treatment of managed investments in Australia and the one-size-fits-all approach it gives investors.

While he does not directly link the advent of SMAs to reducing master trusts fees, Robertson says they will put more pressure on total fees coming down, a result which he welcomes.

“SMAs have been created using the latest technology rather than legacy technology, leading to greater scalability and economies, which should be better from the technology perspective. They could also lead to straight-through processing,” Robertson says.

Irrespective of SMAs, he says master trust fees could afford to drop to about 120 basis points, with greater pressure from institutional and wholesale participation in the market negotiating lower fees for their members.

“I don’t know how managers can charge the fees they do,” Robertson says.

He says given the environment of single digit returns that the market is approaching, as well as the move towards greater transparency, the financial services industry is now more than ever going to have to justify the fees they charge their clients.

“It becomes a question of where they can chew the fat, and that’s why SMAs produce a compulsive argument,” Robertson says.