why individually managed accounts are right, right now - financial simplicity

BEST PRACTICE CLIENT-CENTRIC SERVICE

Why Individually Managed Accounts are Right, Right Now

01BEST PRACTICE CLIENT-CENTRIC SERVICE

Why Individually Managed Accounts are Right, Right NowCopyright Financial Simplicity Australia Pty Ltd 2011

Adviser Perspective

• Consumers can buy investment products directly these days over the Internet

raising questions over relevance of advisers in purchasing investment products,

forcing the need for a superior ‘client centric’ offering by advisers rather than a

product based offering

• By offering a portfolio product directly to investor clients, as opposed to

distributing third party products, advisory groups can attract gross revenues

rather than just product commissions, increasing their share of the value chain

• Advisory groups are hiring specialist portfolio management resources

in-house as it can make economic sense to in-source rather than outsource.

Other groups that are attracted to the IMA offering but do not seek the

competency in house are developing relationships with wholesale IMA portfolio

managers in a ‘collaborative’ fashion (not product distribution fashion).

• ManagedAccountsarewidelyregardedasasuperiorinvestment

‘vehicle’ over managed funds for an increasing coverage of the investing

market, but not the whole market

• TheManagedAccountmarketinAustraliaisalreadysomewhere

between $40 and $80Bn, predominantly SMSFs

• SeparatelyManagedAccounts(SMA)saremore‘productorientated’

where as Individually Managed Accounts (IMA)s are more ‘client

orientated’, providing a superior and higher value client value

proposition, and improved adviser / client relationship opportunity,

particularly important in tough times

• Theunittrustbasedproductdistributionsupplychainisfacing

challenges, and questions over viability and sustainability of this model

in distribution groups are being asked

Executive Summary



Dealer Group Perspective

• Revenues are under siege in declining markets and margin pressure

• Trend in platform fees is heading to 0 (refer ASX AQUA) , as a result platform

rebates as a core revenue stream represents a threat to survival

• However dealer groups can generate revenues and a revenue stream out of a

manufacturing margin, and provide a managed IMA service to advisers.

Platform Perspective

• Whilst many platforms are considering SMAs, there are many factors that

suggest this model will have challenges, including advisory groups with broadly

available tools at low cost can create their own capabilities to offer SMAs or

IMAs (and hence retain that margin) themselves

• However, platforms are also ideally positioned to provide the administration and

technology to support the operation of IMAs by advisers / dealers, reposition to

provide a toolkit for portfolio managers including portfolio modeling technology,

administration and custody of assets

• Such a platform capability is likely to increase embedding in adviser / dealer

workflows and hence customer and asset retention.

Asset Manager Perspective

• Asset managers are being separated from advisers and clients through platforms

– intermediation

• Platform power is putting margin pressure on asset managers

• Many asset managers are seeking new ways of increasing margin by heading back

to retail, either with:

• Managed account products

• Collaborating with dealers / advisers to support them offer IMAs

• This collaboration is forming a new dynamic in the industry.



What Is Needed to Offer IMAs – It is simpler than many think !

• To date, specialist technology has been absent preventing scalable profitable

IMA business models

• This has now changed with new sophisticated IMA technology (uniquely from

Financial Simplicity) that can automate the personalized portfolio experience

with scale

• Such technology is available to asset managers, platforms, dealer groups and

advisers – anyone can participate as costly investment committees, custody

arrangements or research house approvals are not mandatory

• All participants need to operate IMAs is the technology, a place to hold assets

(which could be a simple broker accounts), some model portfolios, a license and a

client base.

Key Impacts

• Institutions may no longer have the power they had to exclusively offer managed

investment products by having a high barrier to entry

• Even the smallest advisory practice can now manufacture their own IMA products

and services and have little or no dependency on existing institutions

• This generation of IMA products and services may be at a much lower cost base

than traditional funds on platforms – perhaps a total cost of 30-100bps rather

than 150-200bps

• Advisory groups offering IMAs may also help them attain higher revenues (gross

revenues not commissions) higher margin (perhaps the significant lion’s share of

the overall value chain) and a deeper tailored relationship with their clients. Some

would argue also with lesser risk.



IntroductionThere has been some considerable debate between the use of managed accounts

over managed funds in the last few years, much of which has centered on whether

managed accounts are a better structure than managed funds. This debate appears

to largely conclude that as an investment vehicle holding underlying assets that are

reasonably liquid and tradable, managed accounts are the clear winner as they can

provide transparency of investments, portability, liquidity and also often the ability

to tailor outcomes to an investor’s specific rules, preferences or constraints.

Whilst such benefits of managed account portfolios are helping many investment

advisory practices offer a superior structure to their clients, there are also a number

of additional benefits that such clients are realizing if the management of their

investments is in an Individually Managed Account (IMA – estimated market size

$50-$80Bn in Australia) as opposed to a Separately Managed Account (SMA –

estimated market size $2-4Bn in Australia). The key difference between an IMA and

SMA is that:

• An IMA is generally offered and operated to the client by the person that they

have a relationship with, and the IMA may consider some of the clients personal

circumstances; and

• an SMA which is typically offered by a ‘product’ manufacturer which produces a

product according to a Product Disclosure Statement (PDS) that is then promoted

by the client relationship manager (advisor) to the client

Whilst there are some great SMA products out there in the market, the subtle

difference between SMA products and IMA services may have considerable

implications, namely:

• That with an IMA, the client often can talk directly to the person who is managing

their investments and making decisions for them. Research of clients of private

wealth managers has indicated that such clients like to know who the person is

managing the investments, and seek communications at a level and frequency that

suits the client, often beyond a quarterly paper report.

• That with an IMA, the resulting investment decisions are often tailored to the

client’s specific situation rather than being solely driven by the specific desires

of a product manufacturer, who perhaps is more focused on his or her relative

performance to their peers rather than the end investment result of the investing

clients



As Roger Montgomery from Clime Asset Management says ‘IMA’s offer

transparency, access to the manager and for fund manager’s willing, accountability.

Most importantly IMA’s ensure that tax consequences relate only to the activity

of the individual. No longer do you suffer financially from the buying and selling of

others.’

In times where many investors are seeking additional support with their

investments, helping them with an understanding of the market and the specific

value and decisions associated with their portfolio are perhaps more important

than ever. If the interest in Financial Simplicity for IMA technologies over the recent

months is anything to go by also, perhaps these key points are now becoming

important enough to prompt advisers and dealer groups to strongly consider an

alternative way of delivering investment value, with a move perhaps from product

distribution (whether managed funds or SMAs) to a tailored client service delivery

model.

Jon Reilly from Vivid Financial says ‘Sophisticated clients demand the transparency

and flexibility that managed accounts can provide. In the exceptionally volatile times

that we have recently endured, the ability to have an open line of communication

between the investor and the people making the buy and sell decisions has been

invaluable. Investors are realistic, and they don’t expect us to time every trade

perfectly. When they know and understand why we own a company in our portfolios,

then the short term price movements becomes less important. ‘

Contemporaneously, a key business issue that advisory groups are starting to

consider is the sustainability or attractiveness of the current sharing of revenues

and fees on the current product/platform/dealer/adviser product distribution

supply chain. This consideration is further fuelled particularly in an environment of

down markets, fee pressures and possible regulatory change from examination of

conflicts of interest, not to mention increasing consumer backlash. In some circles

the issue of practice sustainability is considered in the context that a practice that

relies largely on commissions may be at substantially more risk than one that has

a good mix with fee for service and offering direct investments portfolio services.

These are interesting times perhaps suggesting an evolutionary change in the

advisory practice business model.

To address these issues of sustainability and attractiveness, let’s look at the supply

chain from some different perspectives to better understand why IMAs are quite an

attractive option for many right now.



Adviser PerspectiveWe are seeing an increasing number of advisers that whilst offering valuable

advice, are starting to deal with the reality that investors that can access managed

fund products cheaply, and often with fee rebates, from various discount on-line

providers over the Internet. Within such an information rich Internet enabled world

and direct access to products over the Internet, the role of advisers in any industry

is becoming not just about access to information or product (because everyone can

get this now) but more about putting information in context of their clients. In the

investments industry this means two things:

1) that advisers are needing to become exactly that for the breadth of their

services, providing each piece of advice in context of each and every client

2) that from an investments offering perspective, advisers are in the best position

to manage, assist, or perhaps just ‘direct’ the clients investment portfolio as

they, and often uniquely they, have the client context in mind. This suggests that

offering tailored managed portfolio services (IMAs) is therefore also a far more

attractive client relationship proposition than the distribution of ‘commodity’

products that are designed to service a market segment.

As Jon from Vivid has discovered, ‘The level of communication we provide is

probably the key aspect of strengthening our client relationships. In otherwise

difficult times we have been gratified to receive high quality referrals from our

existing clients, which we see as the best endorsement that we are delivering the

service that our clients are seeking.’

The favouring of IMAs doesn’t stop here. Not only are the client relationship

management aspects of a ‘adviser direct to consumer’ IMA offer an increased

opportunity for client service and deeper relationships, but also business risks and

revenue opportunity looks to have some advantages also. Perhaps consider the

following:

1) By offering an investment service directly to the client, the advisory practice

can get gross fee revenues from the provision of that service rather than trail

commissions from a product, increasing revenue opportunity

2) By being involved in the ‘management’ of client portfolios, this may negate the

need for all or some of the manufacturing margin paid to a fund manager (and

possibly platform fees also), allowing the offering of the IMA at either a lower

cost to the client, or perhaps retaining margin into the business to offer a higher

quality service.



Not surprisingly, many advisers with appropriate skills in house are finding this

approach attractive, however it is recognized that for many advisers, taking on this

active advisory/portfolio management role may be a stretch. We are seeing two

trends that are picking up in pace:

1) Some advisory groups are hiring specialist portfolio manager / trader /

researcher skill sets in house as part of a centralized team to either support

advisers manage their portfolios, or form part of a centralized team that work

with the advisers and manage their portfolios for them

2) There are an increasing number of specialist ‘wholesale’ portfolio management

groups that provide portfolio management / IMA services as a service to other

advisory groups.

This is leading to some interesting industry dynamics forming by where either

advisory groups are offering IMAs direct to the consumer with no external input,

or they are developing collaborative relationships with specialist ‘wholesale’ IMA

groups to do the work for them, yet not losing or assigning the client relationship

or client management function. Like in many industries, I suspect that this

‘collaboration’ (as opposed to ‘distribution’) is going to be a critical part of the

shaping of the industry in years to come.

Jon Reilly from Vivid Financial, who are starting to service not only their own clients

with their own IMAs but also developing relationships with other advisory groups

says ‘Whilst not every business will want to take on the investment management

responsibilities for their client’s portfolios, managed accounts combined with the

right technology means that it is possible for separate businesses to co-operate

and provide investment services to the advantage of their clients. Scalability is the

key to making sure that these businesses can grow in a sustainable manner, and it is

technology that makes this possible.’



Dealer GroupsIt is understood that many dealer groups in the country obtain funding to cover their

costs via rebates from platforms or products, and a ‘cut’ of adviser fees.

With the trend of costs associated with the administration of securities for

investors heading one way, and tending towards zero (perhaps look at the project

AQUA initiative from the ASX), the dependency on platform rebates may have a

limited life left. This raises the question for many dealer groups as to where to

replace such funding and revenue from. Given the margin pressures on the product

manufacturers, it may be unlikely that monies may come from there, suggesting that

funds may have to come from adviser fees, surely only achievable if advisers can

increase their fee cut too.

This is where IMAs look a favorable solution as under an IMA model, either:

a) the dealer group can participate in increased adviser fees by where the adviser

operates a managed portfolio IMA service for clients, or

b) the dealer can participate in helping the advisers do this, essentially being a

service support system (and taking a fee for such) in helping the advisers operate

IMAs.

Perhaps a new function of dealer groups in a world of IMAs is to collaboratively

provide advisers with the core capabilities (research in the form of model portfolios,

technology, and low cost efficient administration). We are starting to see a

number of dealer groups go down this path, developing their role as practice tools

supporters providing a framework for their advisers to operate higher value IMA

services, or even managing the IMA portfolios themselves centrally yet in a highly

collaborative manner with the advisers.

Whilst this may appear to many as being a change to the business model and

represent some risks, the alternative is declining revenues and client control in

offering commodity products, not to mention that the advisers may struggle to

convince the clients to stay paying fees if they can source investments themselves

over the Internet.



9

PlatformsWhilst many platforms are ideally placed to offer SMAs (just add portfolio

rebalancing technologies, a PDS and a selection of model portfolio providers to the

platform and you are well on the way), and I suspect many will in the coming year or

two, what is also becoming apparent is that they are also ideal to provide supporting

services for the management of IMAs for advisers, or their selected portfolio

management partners. The key difference and strength in doing this is that unlike

offering an SMA which introduces new skills, workflows, service levels and risks for

a platform business, platforms already offer a large portion of the infrastructure

to support the operation of IMAs by advisers and dealer groups, the key additional

required piece being only to provide the portfolio modeling capabilities.

Supporting this possible extension by platforms is the fact that it is becoming

an increasingly popular desire by advisory groups to have the portfolio modeling

and manufacturing technologies required to operate IMAs tightly integrated

with an administration platform. This allows IMA providers to deal with a single

administration and technology supplier, which when combined can provide the key

operational ingredients for advisors or their partners to operate IMAs for their

clients.

Not only does the above approach by platforms reduce or even negate the

sometimes challenging issues of integrating platforms and systems by advisers,

portfolio managers or dealer groups, it transforms the platform from being just

a provider of a commodity goods (i.e. administration services) to becoming a key

integrated partner to their customers, increasing both their business value and also

customer (and FUA) retention. I suspect we are could see this becoming the ‘norm’

for platforms in the next year to maintain competitiveness.



10

Asset ManagersA downturn in the global markets is not helping, but is not the only issue for asset

managers these days. The powerful positioning and grasp of the platform industry

is putting increased pressures on fund manager fees, as well as in some cases

requiring ‘shelf fees’ to even get their fund products on the platforms. The platforms

have become for many the ‘gate keepers’ to fund managers as they not only are the

administration platform to replace retail client service for fund managers, but also

represent a hurdle for asset managers to get their product to advisory groups and

investors.

Whilst one option is for an asset manager to set up or buy a platform in order to

get access to retail markets, another solution may be to cut the platforms out and

offer managed portfolio products and services instead, most likely with less overall

costs, most likely less gatekeepers to deal with – and this is sounding attractive to

many. Whilst many are starting to offer SMA products as they head down the path

from funds to managed accounts, some of the more innovative ones may be seeking

to look beyond ‘products’ and start to collaborate with advisers and dealer groups

to help them offer IMAs direct to the client, after all the asset managers have the

portfolio management skill sets, and the advisers have the client relationships

suggesting an ideal fit.

As Roger Montgomery describes some of the benefits to asset managers,

‘Technology empowering managed accounts now makes it possible for boutique

fund managers to profitably offer everyone and anyone access to their services and

performance’.

Not only are such ‘collaborative’ relationships very ‘sticky’, but they are also likely to

be able to offer an end investment product or service to the client at a lower cost,

perhaps with investment administration and reporting of individual underlying

securities performed on platforms. This change in dynamic then may reposition the

administration platforms as exactly that, a place to hold and report on investments,

side stepping the gate keeping role that they have had with controlling the funds on

the platforms.



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So what do you need to offer IMAsSo if IMAs are so compelling a value proposition to the investors, the adviser and

perhaps dealer groups also, what is holding everyone back? The answer to that lies

probably in two key areas:

1) the lack of available technology to date that has been able to support the

complex calculations to perform individualized portfolio modeling and

implementation with scale and efficiency

2) the heavy entrenchment of the prior era’s business model of funds on platforms

with their associated remuneration and rebate structures, possibly further

enhanced with what many regard as a conflict of interests by where the

organisations that own a lot of product manufacturing part (including SMAs) of

the market also own the a lot of the ‘advice’ or ‘distribution’ part of the making,

making it hard for a fundamental change in the broad based industry.

However, we are seeing an ever increasing number of independent planning groups

(and even advisers from tied groups) moving away from the old regime of funds

on platforms to offering individually tailored portfolios (IMAs) for their clients

providing a better value proposition for their client and their business at the same

time.

In relation to the technology, there is no wonder that this has taken some time to get

the market, it is not easy to even define what should happen in a portfolio to take

into account a client’s current portfolio, a model portfolio, ratings on securities, and

then many individual investment rules, preferences and constraints. Then try and do

this for many client portfolios all at the same time – this is a serious data processing

and workflow challenge, a ‘mathematical spaghetti’ says Roger Montgomery from

Clime Asset Management. At Financial Simplicity this has taken us over 10 years

to get right but is now proven and broadly available. Then there is the challenge of

building such technology, supporting it, maintaining it, marketing it and providing it

to businesses at an affordable price point, which I suspect is only achievable over the

Internet. Given gravitation to the need for core competency focus in any business,

I suspect for many that it is going to be a lot easier and cheaper for many to license

this capability from specialist providers like Financial Simplicity rather than try and

build it. Why wouldn’t you ?



12

So what are the key pieces that you need to offer IMAs. Generally these ‘ingredients’

fall into the following areas:

• Investment Research – often in the form of model portfolios that can be

constructed by in house teams or ‘bought in’ from the increasing number of

providers who are publishing such

• Somewhere to keep and report on the assets for the client – either a platform,

custodian, nominee company, broker or discount broker, each usually with a

supporting cash account. This market is getting very competitive and we are

finding that groups seeking outsourced administration are managing to secure

such services at much less than a full WRAP price

• Some form of licensing from ASIC to support the mode of IMA that you are

offering, whether it be discretionary (where you may have authority to transact

on behalf of the client’s account), or non discretionary (needing client approval

for implementing each investment decision – although technically under the

definitions offered by the Institute of Managed Account Providers a non

discretionary offer is not a ‘managed account’)

• Some way of ensuring that client portfolios can be modeled or kept in

line with their selected model portfolios, usually in the form of a portfolio

modeling technology, or should you be seeking to do this en-masse, a portfolio

‘manufacturing’ technology. The reason why technology is most often required

is that dealing with many portfolios, each with individual securities, and doing

calculations across them is a very data intensive task, where the computations

required is vastly made more efficient (if not the only way to do this viably in a

commercial manner) through the use of supporting technologies.

The impact of the reality that pretty well any group that has a base level of skills and

access to the components above can manufacture and operate their own IMAs.



13

Concerns over Discretionary Portfolio ManagementWhilst the term ‘managed accounts’ implies discretionary authority by the

portfolio manager, managed portfolios can be offered in an advisory fashion

(non discretionary) also. However, we are finding that groups that are seeking to

achieve fairness of client servicing (i.e. making sure that all clients are treated

fairly rather than being in a ‘pecking order’) as well as operational efficiencies and

prompt trading, are either currently operating, or seeking to move to a discretionary

mode of operation. There are some considerable benefits to the clients and the

advisory groups operating with a discretionary model (and to a large extent it is

no different than putting monies into a managed fund where the fund manager has

discretion) however there is also, quite rightly, some concern about the operation of

discretionary portfolios given some disastrous cases of clients monies being lost in

the past.

However, unlike many of these disastrous (and often high profile) cases (some

of which perhaps came about with what may be regarded as inappropriate

discretionary trading which has impacted badly on both advisers, licensees and

perhaps the industry also) the new form of IMAs where all trading decisions are

made in the context of the chosen model portfolio and client profile may represent

a very different, and perhaps lesser risk, compliance and risk management challenge

and solution. The rationale here is that the discretion under a model portfolio based

IMA offer is not so much about choosing which securities to trade and when (which

may have been the characteristics of the high profile loss cases in the past), but

actually is more about just authorizing an IMA portfolio manager to do their job

under some defined parameters, the parameters defined by the clients current

portfolio, their chosen model portfolio, and any specific rules, preferences or

constraints that they client has defined. Perhaps there will be the notion of a ‘limited’

discretion license authorization available some time in the future to reflect the

middle ground between total discretion and no discretion.



14

ConclusionWe are in changing times in the retail investments industry. Many consumers appear

to be getting smarter, becoming more informed and seeking answers to how to

achieve the best tax and investment outcomes. Advisers and dealer groups are

also becoming more informed, and have better access to tools and information than

ever before. Product margins are becoming thinner everywhere and the regulators

are starting to take a more pro-active examination of conflict of interest, and the

sustainability and adequacy of retirement savings.

All these trends point to an emergence of a new way of delivering investment value

that will bring collaboration between industry participants most likely on a single

layer of investment administration, not separation of players and multiple layers of

administration.

This new way of delivering investment value is most likely going to have to

simultaneously address and improve transparency, liquidity, tax effectiveness,

client service, reward for performance, sustainability, margin and compliance /

risk management. To achieve all of this though it is unlikely to come about from an

incremental approach to product or service innovation, but more likely as a result

of a whole new way of thinking about delivering investment value, a way that starts

with the client and then allows the different skilled and valuable providers support

them.

Whilst this way has actually been operating for some time, and is where the retail

investment industry started, offering individual client tailored portfolio services by

stockbrokers, this time may be different. I suspect that unlike the past, as Roger

Montgomery points out ‘The most wealthy individuals in Australia, have hitherto

been the only group with access to individually managed portfolios’, this time it will

be a collaborative environment where clients, advisers, portfolio managers and

researchers interact together leveraging the Internet to provide the client with

the best IMA offering, and this time also at a price point that is affordable to the

masses, with many anticipating and delivering such capability at much less than

the understood industry average overall fee to client of between 2% and 3%. We

are seeing a view that a more sustainable overall fee to clients being in the range of

between 1% and 1.5%.



15

This is the growing world of new era IMAs. A new era that simultaneously can remove

inefficiency from the value chain that is lost in ‘administration’ and also improve the

servicing of clients in a compliant, risk managed, tailored, and yet scalable fashion.

This new era of IMAs transcends the scale solution of the last 20 years, that of

producing commoditized products, by leveraging new technologies to do the

complicated processing and decision support for each and all of the clients, rather

than using technologies just to make the current process of product manufacture

more efficient.

I guess time will tell how many of the investment advisory groups will move to this

new era IMA segment of the industry, already estimated at between $40 and $80

billion in Australia alone (a fraction of the SMSF market one might notice), , however

we at Financial Simplicity are seeing that, following the recent global financial crisis,

an increasing number of people are thinking hard about their business models and

client service value propositions, with the new era of IMAs being a very tempting, if

not obvious way forward.

For further information on Financial Simplicity’s technologies please visit – www.financialsimplicity.com.au

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