Ground swell

Ground swell

SMAs have burst onto the financial advice scene, providing advisers with a solution that affords benefits from tax minimisation to investment returns and client engagement

Separately managed accounts (SMAs) have swelled in usage over recent years. Their growth has been propelled by improved technology and an industry-wide need for greater efficiency. Complex regulatory conditions and heightened market volatility are also adding momentum. According to Investment Trends, in 2012 only 16 per cent of financial advisers used managed accounts; by February 2015, however, 20 per cent were using SMAs. Recep Peker, head of the firm’s wealth management research team, says the adoption rate of SMAs will only continue to rise – possibly towards the 40 per cent mark. “With [SMAs] becoming more readily available and more convenient, it will not be surprising to see that put upwards pressure on adoption.” 

Although once a relatively unknown segment of the advice market, SMAs have evolved into an advice solution that boasts benefits ranging from tax and compliance to investment returns and client engagement. Platform providers have responded to the SMA industry’s growth and potential, with more providers offering SMA services. In fact, it’s fair to say that the SMA industry has seen something of a proliferation of products. According to Mr Peker, 11 platform providers offered managed account capabilities in 2015 – up from seven in 2014 and six in 2010.

“As platforms expand their managed accounts functionality, we’ll see that more financial planners naturally have access to managed accounts,” says Mr Peker. With more products on offer, he believes that one of the “biggest barriers” to the use of SMAs has been eliminated. Lukasz de Pourbaix, chief investment officer at Lonsec Investment Solutions, says the growth in the SMA industry is a “natural evolution”. “Over time, there certainly will be growth in demand for managed accounts,” he says.

Technology powered

Technology has undoubtedly contributed to the growth of the SMA industry. Mr de Pourbaix argues that technology has been the driving force behind the industry’s growth over the past 10 years. Toby Potter, chairman of the Institute of Managed Account Professionals (IMAP) agrees. One of the foremost reasons for the increased take-up and availability of SMAs, he says, is that technology now supports platform-based portfolio management. The growth figures by Investment Trends quoted above certainly reinforce the argument that more and more platform providers are offering SMAs.

Hub24 managing director Andrew Alcock argues that technology has made the SMA process far more efficient. SMA managers can easily and quickly hold, buy and sell stocks, while the client retains the underlying ownership of the asset. Technology allows SMA managers to do this across multiple portfolios and for numerous clients.

The adviser and client both benefit from the fruitful relationship between tech and SMAs. Macquarie Wealth Management head of wealth product Cameron Garrett points this out: “Platforms have evolved to create new opportunities for advisers and their clients and improve investment outcomes. We are seeing more managers and models become available to offer Australian investors even greater choice.”

While technology has helped to advance SMAs, however, it is also serving to disrupt the broader financial advice industry. Technology – as most advisers know – can be both a positive force and a somewhat negative one. Praemium chief executive Michael Ohanessian, whose firm provides SMA solutions, points out that technology is requiring advisers to become more efficient. And to hammer home the need for greater efficiency, he says, increased regulation is also adding to the dynamic. “With all the regulatory reform [as a result of] FOFA [and] with all the cost pressure with robo-advice … there’s an awful lot of pressure on advice businesses to thrive in this new world,” he says.

Robo-advice is making its mark, Mr Ohanessian believes: “Robo-advice is going to really hurt [advisers] unless they can be at least as half efficient as a robot. If [advisers] don’t change, they will go out of business.”

‘A’ for efficiency

SMAs provide advisers with the efficiency they need in the changing world of financial advice, says Mr Ohanessian. He points out that the efficiency benefits lie in the structure of SMAs. When using an SMA, an adviser first establishes a client’s risk tolerance. The client is then placed into a model portfolio that matches their risk profile. This model portfolio is multi-asset and is usually managed by a professional investor. After the client is invested, Mr Ohanessian says it’s “set and forget”. Portfolios rebalance automatically and advisers are not required to gain individual client approval each time a change is made to the portfolio. “You’re freeing up the adviser of all this time and you’re delivering a better client outcome,” Mr Ohanessian notes.

Macquarie’s Mr Garrett says that by using an SMA, advisers can manage their client’s assets on an “efficient, streamlined and consolidated platform”. He echoes Mr Ohanessian’s argument, noting the efficiency benefits, as well as the choices advisers have in terms of asset class, strategy and investment style. “[SMAs] allow advisers to build scale and efficiency into their offering, helping to manage the compliance requirements and risk. [This frees] them up to have valuable conversations with clients around asset allocation, life stage, aspirations and risk,” Mr Garrett says.

Kathy Vincent, general manager of NAB-aligned firm MLC, says if advisers spend less time administering portfolios, they can allocate more time to servicing their clients. “Advisers can focus on the overall strategy, rather than being caught up in whether they should buy, sell or hold individual shares,” she explains.

DNR Capital’s head of wholesale distribution Tom Glynn argues that SMAs make a compelling business case. As others have pointed out, he believes SMAs allow advisers to streamline their investment process. “By using an SMA, advisers can focus their attention on servicing existing clients and growing their client base,” Mr Glynn says.

Ms Vincent is certain that advisers will see business benefits when using an SMA: “[SMAs] absolutely help advisers improve the profitability of their practices.” In a report issued by IMAP, it was again noted that efficiency and business profitability go hand in hand. “Practices can achieve greater efficiency and productivity, and develop a more compelling and sustainable client value proposition,” it stated.

Talking tax

Although talking tax may be rather dry, the taxation benefits related to SMAs are significant and can’t be overlooked. IMAP’s Mr Potter argues that by using an SMA, a client never inherits a tax consequence as they would if using a managed fund. Tax consequences are removed, he explains, because each stock is purchased and owned in a client’s name. “Whereas when you buy units in a trust, you buy the trust’s underlying tax position, which may be a very significant tax [obligation].”

Furthermore, tax benefits can also be seen when a portfolio needs to be rebalanced. Hub24’s Mr Alcock explains that within an SMA structure, if an adviser chooses to change investment managers or model portfolios, not all assets need to be sold. The stocks that overlap in a new and an old portfolio can be retained. “You’re not actually crystallising your tax on an asset that you’ve got to sell today and buy again tomorrow,” he says. This can significantly reduce a client’s capital gains tax. Compound such savings over a lifetime and it’s easy to see why SMAs are attractive solutions. Mr Alcock believes the tax efficiencies offered by SMAs add “real value”. He says the benefits and savings outweigh the cost of financial advice itself. 

Reducing risk

The best interest and risk management benefits of SMAs need to be noted. The benefits are best illuminated when compared to other investment structures, like direct equities or managed funds. According to IMAP’s report, if an adviser is using one of these other structures, each transaction performed by the adviser is subject to approval and best interest requirements. “In other words, advisers must be able to clearly demonstrate that each and every portfolio change [is] likely to leave the client better off and clearly aligned to their goals,” the report states. “This is a very onerous obligation.” MLC’s Ms Vincent clearly states that SMAs lessen an adviser’s compliance risk and obligations: “Advisers are decreasing their overall compliance risk as they’re not directly accountable for the share selection and ongoing portfolio management.” 

Investment benefits

Arguably, the most compelling benefit of SMAs lies in their investment capabilities. Namely, trades can be enacted immediately by the SMA manager without the need for individual client approval or for a record of advice (ROA) to be delivered. Mr Potter remarks that being able to trade in a timely manner is essential when trades and market moves are time sensitive. “You don’t have any implementation drag,” he says. Further, Mr Potter adds that the investment professionals managing the model portfolio can react to threshold prices and take advantage of opportunities. This can be done to a far greater extent than an adviser could if running a direct equity portfolio for each of their clients.

Mr de Pourbaix explains that if a trade can be applied quickly, across all client portfolios, the results are considerable. Advisers can provide their clients both return and capital protection benefits. “Where there’s a material risk … where it becomes really [significant], you want to get out of that investment in a timely manner,” Mr de Pourbaix says. Macquarie’s Mr Garrett further explains the investment benefits of SMAs. “Within [an] SMA, the portfolio manager has access to research, resources and market data 24 hours a day, seven days a week, allowing them to make real-time quick decisions for the portfolio based on the investment environment.”

In the context of volatility, this makes sense. Mr de Pourbaix notes that the model portfolios within an SMA structure are constructed by professional investors. “We’re constructing portfolios to ensure that different bits and pieces within the portfolio can perform in a range of market environments,” he says. In times of volatility, the professional design of SMAs really kicks in. According to DNR Capital’s Mr Glynn, clients often feel more comfortable if their assets are controlled by professional investment managers. “In this type of market, many investors (and advisers) feel more confident using a product that they know is being actively managed by an independent, professional and experienced investment team. So in this respect, market volatility improves the appeal of a SMA,” Mr Glynn says. In addition, Mr Ohanessian believes that SMAs are an easier way to manage clients that are “nervous about markets”. “I think [SMAs] are a lot more responsive in helping clients manage through difficult and uncertain times.”

By using an SMA, an adviser essentially outsources direct investment decisions. While this carries benefits, it does raise one issue. If an adviser is no longer involved in stock-picking, how can they justify their fees to clients? Mr Glynn says outsourcing stock selection does not mean an adviser’s value depreciates. “The adviser can also add value in terms of selecting the most appropriate model portfolio; and also in allocation decisions across asset classes which consider their client’s risk profile and personal needs,” he says. “SMA managers, by their nature, don’t take into consideration an investor’s personal needs. This is a significant value add by the adviser.” Mr Glynn points out what most advisers reading this piece already understand – investments only form one part of holistic financial advice.

Not all sunshine

Philippa Sheehan, managing director of dealer group MyPlanner Australia, isn’t sold on SMAs, however. She explains: “Although clients could hold the stocks directly, there was no real control for the client or the planner.” According to Ms Sheehan, SMAs meant that the conversation between adviser and client changed. “When planners [within MyPlanner’s dealer group] started using SMAs, clients started to shift their discussion from goals and objectives to asking, ‘Why did you buy that stock yesterday?’ It was at this point that we realised that SMAs were potentially not the ultimate solution for true objective based advice.”

Mr de Pourbaix disagrees. He argues that because clients retain beneficial ownership of the underlying assets within their portfolio, assets are “more real” and tangible. “[Clients] have visibility of what their underlying investments are via that structure.” Mr de Pourbaix notes that this can result in better client engagement. Mr Glynn agrees, indicating that the transparency afforded by SMAs has positive client impacts. “[Transparency] increases the client’s confidence in the service and understanding of portfolio outcomes.”

Furthermore, Mr Alcock of Hub24 says the engagement benefits of SMAs shouldn’t be overlooked. “In the world of managed accounts, there is more transparency. It allows [clients] to have a more engaged conversation with [their] financial adviser because [they] can identify with what [they’re] buying.” He asks a question to rebut Ms Sheehan’s argument: “Why shouldn’t a consumer have transparency? Why should we hide it [from] them?”

Not for all

As identified throughout this piece, SMAs hold numerous benefits for advisers and their clients. However, it’s worth pointing out that SMAs are not suitable for all clients. Mr Garrett believes that SMAs are not suited to clients who want to choose the specific stocks they invest in. IMAP’s Mr Potter thinks that SMAs don’t suit clients who “have a particular focus on personal control”. In addition, Mr Potter says, SMAs are not suited to clients that have regulatory related problems, such as a charitable trust. Clients that are prone to conflicts of interest through their employment position, for example, also spring to mind as being unsuited to an SMA.

Momentum building

SMAs no longer sit on the outskirts of the financial advice industry. “I think we’ve moved beyond asking ‘what are these things?’ to starting to understand the benefits they can offer consumers,” says Mr Alcock. “There’s growing demand and growing understanding in the marketplace,” he says. MLC’s Ms Vincent concludes that SMAs have finally emerged as a “key structure for advisers who are looking for more control, more transparency and business efficiencies – while not compromising investment quality”.

As SMAs continue to swell in usage, the nature of financial advice will start to change. Because SMAs enable greater efficiencies, says Mr Alcock, financial advice will – and arguably has – become more strategic and client focused. “SMAs and managed accounts have changed the way advice is delivered to clients,” he says. Furthermore, he believes that end-investors see their wealth differently and interact with it in a more engaged manner. This in turn can impact the way an adviser chooses to interact with their client, as well as the level of conversation they can have.

The SMA industry will continue to evolve. It’s therefore important to ask what’s next? Mr Alcock is certain that SMAs will evolve into more sophisticated solutions. “The ability to have mass customisation will arise.” He explains that advisers will be able to customise a client’s portfolio within an SMA structure. This means an adviser may soon be able to disregard or add a certain stocks within a model portfolio. “The ability to manage the portfolios but tailor them for individual [client] needs, but not lose any of the efficiency will be a future step,” Mr Alcock says. “That’s a future step to look forward to.”

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