The naked portfolio

Ben Coombs of Elston Asset Management – winner of the 2019 IMAP Australian Equities Managed Account Award – looks at some of the key client experience considerations to make when constructing managed account portfolios.

Managed accounts are made to be transparent. It’s one of the main reasons why clients love them. But, of course, that ‘naked’ construction has the potential to leave a practice a little bit red-faced, too.

So, how do you provide investors with a ‘look through’ into the underlying assets and decisions of an investment manager, without causing undue client concern?

Let’s looks at some of the key considerations to make when you construct managed account portfolios.  

Transparency: A double edged sword

With transparency comes responsibility. Just think back to early adopters, such as the Antares portfolios on the MLC Navigator platform post GFC. What advisers soon realised is that with the visibility of the underlying holdings comes the inevitable reality that clients’ eyes will gravitate to the positions that are underperforming, particularly with direct equities. This can occur regardless of whether 80 per cent of the portfolio is performing well and to expectations.

What this means as an adviser is that you will be asked questions about these holdings. The question is, will you be armed and ready with the information to answer them?

Holding number and size 

Clients do not want to see meaningless holding sizes in any security. When considering your investment policy, it is important to think about what the client will see in their investment reports.

In a unitised environment, it is possible to manage a larger number of underlying securities in the portfolio because the client only sees the single line item on their reporting. Within a managed account structure, if the portfolio only has $100 invested in BHP, the client will see that and then question the relevance of having such a small holding.

When setting up an investment policy, or at a platform level, it is vital to be conscious of not only the number of securities, but also the size of the holdings, so that they can add meaningful attribution to the overall portfolio performance.

As an adviser, you need to be prepared to answer questions from clients on the underlying holdings – the more holdings, the greater the need to have the relevant information at your fingertips as to why those securities are in the portfolio and the purpose they serve. 

We have run analysis across a range of other managed account portfolios that we see containing as many as 32 managed investments, which may look great from a diversification perspective. However, for the client, they often are delivering a passive beta outcome at an active price due to the overlap of underlying holdings. Not to mention, this can cause a headache for the adviser to understand each of these managers and how their various styles and philosophies work together.

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Transaction reweighting

What will show up on the transaction report should be considered, and working closely with your platform providers and investment managers can mitigate some of the potential client, and importantly, accountant backlash.

At a business level consider the details of your managed account, such as minimum holding size and minimum trade size to avoid clients receiving a tax report with hundreds of transactions contained. This is an important consideration when portfolios are being constantly reweighted by the investment manager and can be controlled at a platform level. It is important to note, that modifying these parameters may cause some divergence from the manager’s own performance reporting. 

A knock-on effect that isn’t often considered is the impact the volume of transactions can have for your referral sources. In our experience, accountants can become disgruntled with managed accounts if it makes their job at tax time more difficult, because these parameters have not been set appropriately. This is particularly problematic if the accountants have not yet been educated in the after-tax benefits of the managed account structure. 

Portfolio turnover 

Clients want to see that their portfolios are actively managed, yet due to the transparency of the managed account structure, they are sure to ask questions about what is going on and why.

However, any given level of activity on the portfolio will mean that for one client there are too many changes and for another client there may not be enough. It is important to get the balance right. Turning over the portfolio too much can be perceived as a brokerage grab, or unnecessary tinkering if not explained correctly. 

An important facet of client engagement is educating the client upfront around the SMA manager’s investment philosophy. Understanding the rationale for investment decisions in the portfolio is critical to ensuring a smooth client experience, as is the timely communication of the investment decisions. A managed account portfolio should aim to enhance the investor experience and improve their buy-in, with the adviser as the strategy and investment expert. 

This is in stark contrast to a managed fund, because investment managers can be in and out of positions, and hide results – both positive and negative – in this opaque environment, without the client being aware of the changes being made nor the performance of the underlying positions.

When constructing and managing portfolios on an ongoing basis, it is important to anchor back to the investment philosophy, being consistent, while also being conscious of what the client sees occurring within their portfolio. 

Horses for courses 

We don’t believe in the ‘active vs passive’ debate, as if the two investment approaches are battling a war against each other and are diametrically opposed, competing for a bimodal outcome at the expense of the other. Instead, both have valid application in certain circumstances.

When constructing portfolios, we begin with a macro outlook first. Then we seek to find the most appropriate vehicle to achieve the market exposure, within a reasonable fee budget for the client whilst not compromising performance. 

For example, within a concentrated market like Australia, where the index is heavily skewed to banking and financial services, we utilise a more active approach to achieve real diversification across sectors and mitigate concentration risk. In more developed economies, like the U.S. and Europe, which are arguably more diversified, we may use passive investment vehicles to obtain the regional exposures at a cheap price point.  

Total cost to client: Best Interest Duty

ASIC has made its intentions crystal clear around best interest duty and total cost to client being a large contributing factor. When constructing your managed account portfolio, ensure you consider not only the management expense ratio (MER), or model manager fee, but the underlying indirect cost ratio (ICR), or total cost to client of the portfolio. Consideration needs to be given to this in conjunction with administration costs and your advice fee. 

As a business, there is a lot of work and due diligence required when either selecting a portfolio manager off-the-shelf, or a partner to build your own private label.

Within portfolio construction, apply a ‘fee budget’ lens to ensure a smooth and compliant transition to the managed account world. While the positive impact that managed accounts can have on practice efficiency is well documented, the adviser needs to be able to articulate to the client with conviction that the new portfolio offering will put them in a better position, not only from an investment perspective, but ideally, at a lower fee. 

We have run across examples of portfolios with a total cost of more than 1.5 per cent due to the myriad of underlying managers within the portfolio. This can make the client transition difficult and leave you open to an argument that the decision to proceed with a managed account strategy has been made with the business, rather than the client interests at the centre. 

Goals based: Predictable income streams

Goals based advice is a term widely bandied about in our industry when it comes to portfolio construction. We also hear of the ‘bucket strategy’ regularly employed by advice firms to ensure that portfolios are constructed to cater to clients’ short, medium and long-term requirements for their capital.

We certainly do not disagree with this approach, however, implementation can be cumbersome and defeat some of the efficiency gains that a managed account strategy can offer.

Consider a client in retirement phase. The challenge is to ensure they have enough cash to be able to meet their lifestyle requirements. When constructing portfolios, one of the benefits of a managed account structure with direct assets is the ability to forecast income, including franking.

This provides the adviser with the strategic tools to actively manage the client’s short-term cash account at review, and re-assess their requirements and strategic goals, with a level of certainty that the income from the portfolio will continue to support their strategy and meet the client’s needs. See Chart 2.

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Performance

Ultimately, this is how your clients will assess the managed account and the portfolio construction. The portfolio needs to have performed in line with client expectations and to meet their goal requirements.

When considering a manager to partner with or use off-the-shelf, consider their track record, the experience of the portfolio managers, the depth of the investment team and importantly, their experience when it comes to running portfolios in a managed account structure. 

Communication: Enhancing the client experience

Enhancing the client experience should be central to constructing portfolios in a managed account strategy.

Given the more transparent nature of the portfolio for clients, communication from the manager to the adviser and client is crucial to successful implementation. At the point of roll out, the adviser’s delivery of the investment philosophy with conviction and managing the client’s expectations, is pivotal when recommending a managed account. 

The ongoing communication proposition is what sets a successful managed account strategy apart. It is important that the manager and the business stand by their investment decisions, links them back to the investment philosophy, and provides the adviser with timely communication for portfolio changes to enhance the perception of the adviser in the client eyes.

Be conscious that the communication should be pitched in client language at a level that they can understand, without investment jargon, so that the adviser can utilise this to enhance the overall client value proposition. 

Win, win, win

Constructing managed account portfolios requires consideration of multiple stakeholders and the knock-on effects, including advice staff, back-office, referral partners, investment managers, administration platforms, the licensee, the regulator and at the heart of it all, your clients.

Continually anchor back to the questions: Why is this better for my client and their experience than what we are currently doing? How do managed accounts enhance the advice proposition? 

When implemented well and in consideration of the foreseen and unforeseen consequences that can occur, managed accounts can provide:

  • a win for your business efficiency and consistency of portfolio delivery;
  • a win for the manager or investment consultant that you choose to partner with; and
  • a win for the client through enhanced transparency, increased communication, more consistent performance and ideally, a lower total portfolio cost.

Ben Coombs is Senior Distribution Manager at Elston.

Elston takes a consultative approach with the businesses that it works with and keeps the client at the centre of this process. It offers managed account portfolios off-the-shelf on platform and can work with advice firms to build their own private label managed account portfolios. Ben Coombs can be contacted on 0411 126 442 or Mark Smith on 0405 680 715.

WARNINGS AND DISCLOSURES: This material has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained in this material is General Advice and does not take into account any person’s individual investment objectives, financial situation or needs. Before making an investment decision based on this advice you should consider whether it is appropriate to your particular circumstances, alternatively seek professional advice. Where the General Advice relates to the acquisition or possible acquisition of a financial product, you should obtain a Product Disclosure Statement (“PDS”) relating to the product and consider the PDS before making any decision about whether to acquire the product. You will find further details of the service we provide and any cost to you within the Financial Services Guide. Any references to past investment performance are not an indication of future investment returns. Prepared by EP Financial Services Pty Ltd ABN 52 130 772 495 AFSL 325 252 (“Elston”). Although every effort has been made to verify the accuracy of the information contained in this material, Elston, its officers, representatives, employees and agents disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this material or any loss or damage suffered by any person directly or indirectly through relying on this information.

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