Covering the managed account bases

Managed accounts are becoming increasingly popular investment vehicles, but with different compliance obligations for advisers. Matthew Esler examines what to consider when recommending these types of structures.

There’s no doubt managed accounts are now a mainstream platform and investment option for financial advisers and their clients. According to IMAP’s latest “Managed Accounts FUM (funds under management) Census”, as at 31 July 2017 there was $47.9 billion in total allocated to these investment vehicles, representing a staggering increase of 22.4 per cent over the previous six months (from $39.17 billion).

We could debate why it’s taken so long for managed accounts to gain traction in Australia, but let’s leave that for another time. More useful for financial advisers who are now actively recommending managed accounts is to assist them to properly identify all the benefits and risks they need to make clear to investors.

The keys to recommending managed accounts, and properly articulating the benefits and risks in a statement of advice (SOA), include:

1. Know the type of managed account platform being recommended.
2. Recognise the benefits and risks of investing in a managed account.
3. Understand the managed account portfolio, ‘model’ managers and underlying constituents.
4. Ensure you have the necessary research required by your licensee.
5. Comprehend all the costs and potential conflicts.

1. Know the type of managed account platform being recommended

When providing any kind of product replacement advice, not only do the general conduct and disclosure requirements apply, but the adviser also must satisfy additional requirements. Regulation 175.248(e)(i) of Regulatory Guide 175 – Licensing Financial Product Advisers – Conduct and Disclosure stipulates the adviser must “conduct a reasonable investigation into the financial products that might achieve the objectives and meet the needs of the client that would reasonably be considered relevant to advice on that subject matter”. As the Financial Planning Association has recently advised, this would include investigating whether the existing platform was suitable, as well as the recommended platform, and alternatives considered but not recommended.When recommending your clients invest in a managed account platform it is important you understand and can explain the type of managed account platform being considered. For example, is it an investor-directed portfolio service (IDPS), IDPS-like or a managed discretionary account (MDA) platform (see Table 1)?

Table 1

Table 2

The type of managed account platform not only determines the type of managed account portfolio – MDA, separately managed account, individually managed account or unified managed account – but how they are governed. It also determines the operational functionality of the underlying managed account portfolio. This in turn determines minimum investment and contribution levels, transaction processes and costs, and the types of securities available under the managed account.

Different platforms also interpret relevant legislation and regulations differently. A good example of this is in relation to conflicted remuneration and payments being made to the licensee through the product – some platforms have employed client consent, while others employ the rebuttal approach. This has various impacts, including how the platform communicates with your client and manages your client investments. For example, in some circumstances clients not consenting to something from the platform may lead to them being forced to exit the managed account portfolio and often without the adviser’s knowledge or control.

Practices and licensees looking to establish their own managed account platform and portfolios are encouraged to consult with an independent expert capable of assisting them in analysing the range of available managed account platforms, as well as their particular benefits and disadvantages.

2. Understand the managed account portfolio

Managed accounts are often compared to managed funds and direct equities, however, this is an unfortunate comparison. They are actually a level below both direct equities and managed funds because you can invest into direct equities and managed funds within the managed account portfolio itself. If the managed portfolio is investing into direct securities such as equities and exchange-traded funds (ETF), investors will gain the benefits of direct ownership, tax efficiency and transparency. However, if they are investing in a managed account comprising just ETFs or managed funds, these benefits disappear.

Conversely, having equities within the managed account portfolio leads to more limited investment options and lack of derivatives exposure and enhances performance leakage and investment and contribution requirements. This is due to the lower weightings to equities holdings. So there is a balancing act between the benefits and risks within the managed account that needs to be discussed with the client.

3. Recognise the benefits and risks of investing in a managed account

Managed account providers often discuss the benefits of managed accounts – transparency, tax efficiency and administration efficiency – the so-called ‘record of advice (ROA) killer’. But seldom do you hear of any risks. It is imperative when recommending managed accounts you are acutely aware of the risks involved and can explain these to clients. Table 2 highlights some of the benefits and risks associated with investing in a managed account.
A key risk financial advisers typically aren’t made aware of until after they have invested their clients in managed account portfolios is performance leakage. Managed funds have long been criticised for performance leakage, however, managed accounts performance leakage can be worse (because of an under-allocation to the model). This is specifically where there are direct shareholdings within the managed account. The actual performance of the client’s portfolio can differ significantly from the performance reported by the model manager. For example, a 100 per cent allocation to the model may have achieved a 10 per cent return over the past year. However, most clients’ portfolios will be allocated differently to the stated model, often a function of the client’s initial investment or ongoing contributions not being sufficient enough to purchase 100 per cent of the model. In these cases, some platforms allocate only to those assets able to be covered by the investment. Other platforms don’t allocate at all, holding funds in cash, until sufficiently able to purchase 100 per cent of the portfolio (remember you cannot buy part-shares, unlike units in a managed fund).

4. Comprehend all the costs and potential conflicts

Managed accounts were traditionally seen as a way of managing direct equities. However, with investment managers wanting the whole pie, rather than a piece of it, and the focus on asset allocation being the key driver of returns rather than stock selection, managed account providers quickly realised diversified managed accounts were the answer. What was meant to be a tool to reduce cost (by investing a portion in relatively low-cost equities), quickly became another cost layer with managed account portfolios either being made up wholly of managed funds, or wholly of ETFs, both of which have additional direct costs charged to the clients (which is why advisers have seen an increase in indirect cost ratios of these previously seemingly cheap portfolios).

On the flip side, higher exposure to equities within the managed account leads to greater trading and potentially greater transaction costs.

5. Understand when the statement of advice is not required

Within a more traditional managed fund model portfolio there is typically a rebalance each year whereby the allocations within each underlying asset class are rebalanced back to the client’s risk profile. This generally requires an ROA to be completed as part of the annual review. Within a managed account, because the investment manager can rebalance the portfolio at any time, the need to rebalance at the annual review is removed. This has many commentators calling managed accounts an ROA killer.It is important financial advisers understand when a SOA is not required with respect to managed accounts. Under Regulation 179.145, the Australian Securities and Investments Commission states the following:

A SOA does not need to be given in the case of further advice, including the annual review of the investment program, provided that the following requirements are met:

1. you have previously given the client a SOA setting out the client’s relevant circumstances in relation to the advice (the ‘previous advice’);
2. the client’s relevant circumstances in relation to the further advice (taking into account the client’s objectives, financial situation and needs) are not significantly different from the client’s relevant circumstances in relation to the previous advice; and
3. the basis on which the further advice is given is not significantly different from the basis on which the previous advice was given.

Where clients are invested in managed accounts, we would typically warn financial advisers this is not a cause for celebration because you have removed the administration burden of the ROA. This is because we would encourage as much interaction with the clients throughout the year as possible, so the ROA would simply be replaced by a portfolio report highlighting the buys and sells and changes that went on within the portfolio over the past month, quarter or year. Alternatively, forget the paperwork and have a chat with your client instead.