Master trusts, fund managers: no longer like apples and oranges

There is a generally accepted view in the financial services industry that a master trust is an administration platform that administers a whole range of investments for retail clients in one service. For the sake of argument, a master trust is defined as including wrap services, retail superannuation master trusts and ordinary money retail master trusts.

Master trusts such asAsgardorSummitwere developed to clean up the paper work in financial planners’ back-offices. Prior to the advent of master trusts, financial planners seeking fund manager diversification for their clients, would invest directly in several retail products. The clients would sign many application forms, many cheques would be written, and everything entrusted to the mail.

The major disadvantages of this process were:

n Papers and cheques were going everywhere;

n The planner needed to chase up every fund manager individually as to the progress of each investment;

n When the annual statements were received from each fund manager, the planner had to do a lot of time consuming work in consolidating the numerous annual statements for the client;

n Capital gains and other taxes were difficult to calculate; and

n Switching investments at a later date was time consuming, as the redemption proceeds had to be received from one manager before the proceeds could be sent to the next manager.

The financial planner was drowning in paperwork. Master trust services were thus developed. In summary, they did three things:

n Transferred a lot of the planner’s back-office paperwork to the master trust administrator;

n Each fund manager dealt with the retail client via the master trust administrator; and

n The retail client, via the master trust, invested in wholesale or mezzanine funds offered by the fund manager, instead of retail funds.

Initially, master trusts were developed by financial planning groups, purely as a survival strategy to save planners from being buried by the paperwork. Two factors soon became apparent to the administrators, planners, and fund managers:

n If an individual fund manager underperformed, or otherwise fell out of favour, then the adviser would simply recommend another manager, and stand an excellent chance of hanging on to the client. Retail clients thus became ‘stickier’, and the value of a particular level of assets in a master trust had a higher value than for the value of the same level of assets in direct retail products. Clients were advised that they would only have to pay a wholesale buy/sell margin within the master trust, which was significantly cheaper than if they moved their funds out of the master trust.

n A large amount of the profit margin in the total financial services market had shifted from the fund managers to the master trust administrators.

So the game had shifted from the fund managers to the master trust operators.

The fund managers then changed their strategies. Many of them developed their own master trusts (Norwich-Navigator,AXA-Summit) or purchased master trusts (MLC-Flexiplan,Westpac-BT Wrap). The fund managers then had two separate income streams:

n Income from their wholesale or mezzanine funds sold through master trusts when their investment brand attributes were good; and

n Income from their own master funds, which were distributed by their own dealer groups and/or external financial planners.

The setting up of master trusts, initially by financial planning groups and then by fund managers, was a brilliant business strategy and well executed. Both financial planners and fund managers thought that they had removed a significant amount of business risk.

The master trust owners thought that they were no longer at risk due to poor investment performance. Every master trust client had a (slightly) different portfolio, different cash flows, and so it was difficult for an individual client to compare their own performance with any of the investment surveys.

The financial planner was selling investment performance in a way that was difficult to undertake a proper evaluation of the investment outcomes. The master trust administrator was in the administration business, not the fund management business.

There was one little niggling thing though, for both the master trust operators and the financial planners: ongoing changes in the list of preferred investment portfolios.

Most financial planners have a preferred list of investments, which they take from their dealer group’s approved list of investments. The planner will then use several of these products to construct an appropriate portfolio for their client, depending on their client’s risk/reward preferences.

If the financial planning group has five different generalised risk profiles for their clients, they will often have just five combinations of preferred investment portfolios. If the client fits profile A, then they usually get portfolio combination A.

What happens if one or more of the investment portfolios is removed from the dealer group’s approved list of investments? The planner has a duty to contact all of his clients, advise them of an alternative investment portfolio that is appropriate, and get them to complete the paperwork authorising the master trust to execute the switch of investment portfolios. This includes following up on clients who do not respond the first time.

Imagine that the planner has 200 clients. That means at least 200 letters, follow-up phone calls, some meetings for clients who request more information, and checking 200 transaction confirmation advices from the master trust. That’s a lot of work for no extra revenue.

What about the master trust operator? He has to process at least 200 switch forms. While he may charge a switch fee for each switch, this volume of work will not be profitable and will disrupt his normal business activities.

In response to the problems with changing preferred investment portfolios the master trust operator then introduced their own series of multi-manager investment portfolios, with their own brand. This was sold to the retail clients on the basis that the multi-manager portfolio would be expertly managed by either their own research group and/or external specialist asset consultants such asvan EykorMercer. Both the financial planner and the master trust operator had a significant reduction in workload.

These master trust operators are now fund managers. While they outsource the management of individual pools of assets, they have now taken full responsibility for:

n Choice of investment managers;

n The way those investment managers are combined in a particular portfolio,

n The ongoing performance review, and replacement of those managers; and

n Managing the transition of assets when one manager is replaced.

Investment outcomes can be measured and evaluated. Competition is better, the counter argument says, because there are 10 managers in the configuration, the portfolio’s performance will always be somewhere near the median performance in the Assirt or Mercer league tables. Nobody fires an investment manager for near average performance. Master trust operators are safe from being fired due to poor investment outcomes.

Isn’t it time, however, for a new type of investment performance survey? What about a table that measures the performance of just the multi-manager portfolios? It would need to be split up into each risk/return category, such as growth, managed, conservative, Australian shares and so forth. The survey could even state the name of the asset consulting firm that the multi-manager portfolio used.

We could then have a proper evaluation and comparison of multi-manager portfolios.

We might then get to the situation where master trusts start offering additional multi-manager investment portfolios to their own. I don’t believe you can offer a multi-manager portfolio without calling yourself either a fund manager or an asset consultant.

By developing multi-manager portfolios, master trust operators have unwittingly taken back a large part of the business risk they thought they had eliminated by divesting business risk associated with investment outcomes. And the astute investor needs to recognise this.

Peter Worcester is a financial servicesindustry consultant.