Cerulli report: Australian fund management and Asia

Cerulli Associates, Asia Pacific Edge, April 2012

Australia 1: Setting the scene

Australia represents a sophisticated and powerful asset management industry, and one undergoing a period of unprecedented regulatory change. It presents useful lessons for Asia Pacific nations, particularly those that are in the early stages of building a pension fund sector, on how the industry is likely to mature over time – and what challenges appear along the way.

Pensions are the key to understanding Australian asset management. Australia boasts one of the world’s largest pension fund sectors, dramatically out of step with the scale of its population. In December 2011 superannuation funds – which is what pension funds are called in Australia – had A$1.257 trillion under management for a population of just over 22 million. The scale of these assets is magnified on a world scale by the rise of the Australian dollar, which last year crossed 1:1 against the US dollar and has continued to strengthen since, having been worth half that just a few years earlier.

These pension funds completely dominate the country’s managed fund industry, accounting for just over 70% of the aggregate $1.782 trillion under management; public-offer (or retail) unit trusts account for only $263.27 billion, and life insurance assets $227.56 billion.

Underpinning this exceptional scale is the superannuation guarantee (SG): a requirement that employers pay the equivalent of 9% of an employee’s salary into a complying super fund. Since its introduction in 1992, this has kept a flood of money moving into the sector regardless of market fluctuations or individual sentiment. The SG is intended to get bigger still, with the government pledging to phase it gradually upwards to 12% by 2020 (this legislation is before parliament at the time of writing). Consequently, long-term forecasts for superannuation assets tend to be exceptionally high; a 2008 forecast from the Australian Treasury envisaged A$3.83 trillion by 2025, while private sector estimates tend to be higher still. Deloitte, for example, expects total superannuation system assets of $3 trillion by 2020 and $6 trillion by 2030 (although as recently as 2009 it was predicting $7 trillion by 2028, showing how market volatility in recent years has impacted long-term expectations).

This SG pledge, and the difficulty of withdrawing superannuation assets before retirement (or at least partial retirement) explains why, in the very volatile fourth quarter of 2011, super fund assets increased while retail unit trusts and life insurance assets declined. It requires a major reversal in asset values for total superannuation assets to decline over any significant period, and this near-guarantee of stable and significant assets represents the lifeblood of the Australian investment management industry.

That said, Australia is undergoing a period of unprecedented regulatory review in financial services, much of it with direct relevance to the investment management industry. In particular, two reform initiatives are highly important: the Future of Financial Advice, or FOFA, reforms; and the Stronger Super reforms, also known as the Cooper Review.

Both of these are discussed in more detail in the chapters on distribution and superannuation later in this guide. But in brief, FOFA seeks to change completely the remuneration model for the financial planners who put Australians into investment products. Australia is an extremely highly intermediated asset management industry, with financial planners guiding individuals on their investments, usually through mastertrust or wrap platforms which dominate fund flows. It has long been commonplace for funds to pay a trail commission back to the planner, often indefinitely; similarly the platform industry often uses volume-based rebates for funds which are distributed through them. But over the last decade, more and more planners have instead opted for a fee-for-service model, and the FOFA reforms effectively make that law: no longer will commissions be permitted in Australian investment management, the argument being that they create a conflict for anyone purporting to offer independent advice.

The Cooper review set out to examine the structure and efficiency of the superannuation system. Its key conclusion was that a new, low-cost superannuation fund should be developed as the default fund for Australians. All super fund providers would be able to develop such a fund; providers will have to accept new default flows into MySuper from October 2013 onwards, and would then have just under four years longer to migrate balances. This is a significant development: fund researcher SuperRatings estimates that 80% of individuals use a default fund, which gives some indication of how much wealth will be affected. It is expected that these funds will carry a fee of around 1%; industry effort will therefore revolve around providing such a low-cost fund and still making it cost-effective to operate.

One challenge for Australian fund managers and intermediaries is that much of the legislation is still working its way through Australia’s two-house parliament. People know at a high level what is coming, but don’t have the detail. At the time of writing in late February, neither My Super nor the FOFA provisions were legislated. Both were very likely to go through, but there was still scope for amendment, and then accompanying regulation would follow. For example, MySuper involves three separate tranches of legislation, one of which has passed the House of Representatives but is still before a parliamentary committee, one which is in exposure draft form and is about to be introduced, and a third that is not yet even publicly released. Yet the MySuper regime is supposed to start from July 1 2013, with the Australian Prudential Regulatory Authority intending to have new licensing requirements in place by January 1; mandatory default contributions are required to be in MySuper compliant funds by October 1 2013. Many in industry think this is pushing it, and delays are not unlikely.

The same is true with FOFA, which is supposed to start on July 1 this year. Fund managers who have met with the relevant Australian minister, Bill Shorten, recently say he appears willing to consider extensions to implementation timetables, probably in the form of a one year transition period within which industry must comply.

These are uncertain times in this successful industry; one fund manager describes a tsunami, another a perfect storm, in reference to the twin barrels of changing legislation at a time when market sentiment is toxic. As if that weren’t enough, there is heavy competition from retail bank deposits, with Australia offering some of the highest interest rates in the developed world and attracting a lot of discretionary investment dollars that might otherwise have gone into funds.

But there’s no denying that Australia has been extraordinarily successful in building an engaged, educated national investor base, who are increasingly well provided for in retirement. (Similarly Australia’s Future Fund, the closest thing the country has to a sovereign wealth fund, is a rare example of a developed world nation having looked ahead to an unfunded pension liability and built a fund to deal with it 20 years in advance of it being needed.)

The lessons in all of this for Australia are many, and constitute a part of every subsequent chapter. But a few stand out: mandatory contributions are what builds a pension fund industry; no matter how clever and complex the available options, most people stick with a default option; and that everything eventually comes back to simplicity, transparency, and low cost.

Chapter 2 – Intermediation and distribution

Australia is one of the world’s most intermediated markets for asset management, both in terms of the prevalence of investment platforms (mastertrusts and wraps), and the dominance of financial planners who put investors on to those platforms.

There are around 16,000 people who call themselves financial planners or advisors in Australia; 8,500 are advisors who are members of the Financial Planning Association (5,700 of them certified financial planners, the highest certification available) serving at least three million clients.

As of September 2011, platforms handled $405.65 billion of assets, according to researcher Plan For Life – that is, considerably bigger than the entire unit trust industry outside of superannuation. That AUM figure has actually fallen over the last year – it stood at $417.6 billion in September 2010 – although this was chiefly due to falling asset values in the second half of 2011 (masterfunds, the catch-all term Plan for Life uses for wraps, platforms and mastertrusts, dropped $23.4 billion or 5.5% in the September 2011 quarter alone).

One interesting lesson for Asia is just how dramatically platforms can take control of an industry. For many years this has had a great impact on the way the broader asset management industry has behaved. For any fund manager to get noticed, it must first get its funds onto the investment menu of a suitably wide-reaching platform. If it doesn’t, then even if an investor has heard of a fund – perhaps through performance, or a newspaper article – if it’s not on their chosen platform’s investment menu, they will likely never invest in it. One would expect this to be a hurdle to launching new, boutique fund managers, since one has to generate a decent three year performance track record before a platform will even look at a fund, and only then can it start attracting retail money; in truth, though, Australia remains fertile ground for new managers going it alone having cut their teeth at a bigger organization.

Another interesting finding is that after a while, a small number of players totally dominate flows. There are at least 60 vehicles that fit the platform/masterfund term in Australia, but as of September 2011, five of them (BT, NAB/MLC, AMP, Commonwealth/Colonial and OnePath) accounted for 77.3% of total assets, and the top 10, 95.7%. It’s a pattern that becomes more pronounced with every passing year; in September 2009, 8.9% of assets were held outside the current top 10 names.

Distribution is one of the areas that will be most acutely affected by regulatory reform. The financial planning industry is firmly in the sights of the FOFA reforms, which seek to remove commissions from financial advice. In fact, for many years, many planners have either seen this change coming or have felt that they didn’t like the commission model anyway, so have operated on a fee-for-service model; this will now become the norm.

From July 2012, there will be a ban on conflicted remuneration structures, which includes commissions and any form of volume-based payment; there will be a legal requirement for financial planners to act in the best interests of their clients and to place the interests of those clients ahead of their own; and the introduction of an adviser-charging regime, which gives customers flexibility on how they pay for advice. It’s the axing of trail fees that will have the biggest impact on planners, while platforms and fund managers will be affected by the removal of shelf fees, which get funds on to investment platforms.

For many planners and platforms, one of the main challenges is actually technical. There is a great deal of IT work involved in taking commissions out of the system. One of the leading vertically integrated groups in Australia – fund manager, platform administrator, planner group and bank – explains that the process involves product changes, to remove fee structures; platform changes, to implement ‘opt-in’ provisions (which require that clients specifically state that they want to continue receiving advice from a planner, rather than an arrangement just drifting); the implementation of training systems for planners, who will have new education systems and will have to sit exams; procedural changes, in order to ensure that the ‘best interests’ requirements are being met; and general IT changes. For example, in October it was announced that managers have to send a fee statement to existing investors, not just new ones as had previously been expected, setting out fees charged for financial advice. While that sounds simple, for a large institution it involves significant time for an already preoccupied IT team.

Planner groups expect to see their margins squeezed, but not for the reasons one might expect. Colonial First State, for example, has had commission-free products in the market since 2004, and today the vast bulk of flows coming through its platforms do so in these products. While Colonial has many aligned financial planners, they have been charging in a commission-free environment, with explicit fees for advice, for some time. But the costs will rise because of the education and training, opt-in administration, and IT costs. So the impact is not on the revenue side but the cost side.

For IFAs, the impact could be considerable. One major group estimates that IFAs today are 23% of the market, and says it will likely shrink considerably. Independents are moving into vertically-integrated models where it is easier to cross-subsidise advice. A common view is that, for independent planners, it is better to be either really big or really small, so within a big dealer group or a boutique; the middle will be squeezed out. To an extent, this may drive innovation: some IFAs may become their own product provider, outsourcing administration but becoming a responsible entity or trustee themselves, for a fee. But again, only dealer groups with significant scale can afford to do that. It is unlikely that the government intended to shrink the number and role of independent financial advisors in Australia, but many think it will be a by-product of changing regulation.

While some planners are facing tougher times, others see a long-term benefit: a more widely admired profession that becomes an advocate of the investor, one that is unquestionably on the side of the client without conflict. This would be something of a turnaround: 10 years ago planners felt themselves constantly in the firing line of media, investors and regulators alike, often unfairly. And there is still clearly money to be made in giving financial advice, even if some individuals have struggled with the idea of paying up front for advice instead of through a barely visible (and often forgotten) trailing fee. Those who have long operated on fee-for-service feel vindicated by the change and hope they will benefit from everyone else being forced to follow a model they have long been practising.

Platforms expect some undermining from regulatory change; the question is whether the likely extent of it is cause for alarm. There has already been a move to off-platform investments in recent years; one leading platform group says that advisors were putting about 80% of their business on platforms five years ago, and now it’s close to 70%, driven by planners trying to lower the costs to clients and increase their own remuneration by avoiding a platform and instead perhaps using their own software. Does FOFA – “unwinding the nexus between client balance and advisor fees”, as one administrator puts it – mean the need to use a platform reduces? It probably does, especially when see in the context of another shift, which is reduced use of managed funds in favour of direct shares and ETFs (discussed in more detail in part five). Still, the power of platforms is such that they can afford to lose a little market share and still be comfortable.

Since the big platforms are owned by the banks anyway, they have a way to avoid losing out from any migration away from platforms: using the banks to sell investment product. BT Super for Life, for example, is a straightforward, low-fee product sold largely thought the Westpac branch network and online. It is, competitors acknowledge, hard work but successful, and we are likely to see more of this approach.

What does this all mean for fund managers trying to get noticed? One school of thought has it that, as commissions drop out, individuals may go directly to fund managers to make investments rather than through the heavily intermediated route of planner and platform; however, in practice, most fund managers don’t seem to hold out much hope for that, so entrenched have platforms become. Instead, some argue there will be a more differentiated range of platforms: some geared towards self-managed super funds (see chapter 4), some for those who want a lot of choice, and some more plain vanilla.

Some feel that it will become harder than ever for new boutique managers to get distribution; as things stand, they generally have to get several years of good performance to get onto an investment menu, and then pay a volume-based commission or shelf fee in order to be distributed through the platform. With the rebate and commission mechanisms ending, will it be even harder to be noticed and distributed? When one adds to that the ever-increasing burden of compliance and regulation, some feel that fewer and fewer fund managers are going to want to go it alone and start their own boutiques.

That’s the Australian picture. What does it mean for Asia? Well, there is no Asian market where financial advice is so entrenched, nor where investment platforms are so powerful. It seems unlikely, in bold and brassy Hong Kong, that people would be willing to put an intermediary in the way of their direct investments.

Nevertheless, it is likely that some degree of independent financial advice will evolve in Asian markets as it has elsewhere in the world, a function of growing wealth, increasing investor sophistication, and frankly a fear of losing money through ill thought out investments. When that happens, the lessons of Australia are: people billing themselves as independent advisors will eventually be forced to be truly independent by changing regulation; and platforms bring great convenience but also make the big players ever bigger.

Article 3: The dominance of pension funds.

How is it that a country of 22 million people has built one of the world’s largest pension fund sectors? The answer is straightforward: mandatory contributions.

Without the superannuation guarantee – and without the cumulative effect of it having been in place for 20 years – we would be looking at a very different industry in Australia. People have the best of intentions about saving for retirement, but unless explicitly instructed to do so by law, it is generally not in their nature to lock their money away for 40 years. Incidentally, the burden of superannuation theoretically falls on the employer, who must pledge the equivalent of 9% (soon 12%) of salary to a complying super fund); however in practice when one is offered a job in Sydney, the super component tends to be expressed as part of the total package, making it very much the individual’s money that is being put away for the future.

This is why super fund assets stood at A$1.257 trillion in December, and why even the more conservative projections have that figure trebling by 2025. This is also why the pension fund industry is so much larger than the discretionary investment management industry: Australians are keen and canny investors, but how much more money do they want to put to work when already 9% of their wealth is going towards their retirement? Laws around superannuation are notoriously fickle – every new government seems to review, tweak and amend them – but over the long run, rules have generally made it advantageous to pledge money to superannuation rather than to invest it elsewhere. In a country where the top tax rate nears 50%, anything that saves on the tax bill is considered enormously attractive.

For people in Asia looking at the Australian super fund industry, what can be learned? First, clearly, that in order for a truly significant pension fund industry to be built, contributions have to be significant, and mandatory. There are beginnings of this in Asia – notably Hong Kong’s MPF and Singapore’s CPF – but so far the mandatory requirement is well below Australia’s 9%. Even when such a heavy requirement is imposed, it takes years to reach critical mass, but once it does, the growth is dramatic. Definitely, tax incentives help – though they clearly help less in low-tax Hong Kong or Singapore than high-tax Australia – but it’s fundamentally about being made to invest.

As an example of how increments in the level of mandatory contributions can make a big difference over the long term, Deloitte argues that the proposed increase in the SG rate from 9% today to 12% by 2020 should lead to an extra $408 billion of superannuation wealth by 2030.

It’s worth noting that this has knock-on effects, too. At the time of writing, the Australian superannuation industry was slightly larger than the entire market capitalization of the Australian Securities Exchange, and it’s likely that superannuation volumes may well grow faster than Australian stock market value does. A very large proportion of those super fund assets are deployed domestically; when APRA last released statistics, 29% went into Australian shares and a further 10.1% into Australian fixed interest. Since most superannuation money can’t be withdrawn, that makes it very sticky money, which can be helpful to the broader market in times of volatility: investors can’t all just run for the exits, and so to an extent it acts as an anchor or buffer to market performance, bringing welcome stability.

Some Asian markets may welcome such a development, as it would help to alleviate the problems that exist today when foreign capital flees their markets at the first sign of volatility elsewhere. The lack of large and entrenched institutional investors like pension funds in Asia is considered one of the key reasons that Asian stock markets are volatile, and also why Asian markets occupy a disproportionately low weighting in global equity indices relative to the growth rates of their economies.

The MySuper development is also relevant to the Asian pension fund industry, as it gives a glimpse of where a mature pension fund sector eventually ends up.

The super fund industry has evolved considerably over time in Australia. The structural differences between the various options – retail, industry, corporate, public, self-managed – are discussed in the next chapter, but it’s fair to say that the industry has been characterized by ever-increasing choice, particularly since July 2005 when the ‘choice of super’ rules came into effect and allowed employees to go with other providers beyond their company’s chosen super fund. Choice is not just about providers, but within an individual provider’s range of options: most super funds offer a balanced option, growth, high growth and conservative, and in some cases various other mix and match options.

But what MySuper tells us is that eventually everything comes back to some key common denominators: a drive for simplicity, transparency, and low fees. That’s an unarguable proposition for investors. Two years of study in the Cooper review ultimately concluded that investors’ money was often being frittered away unnecessarily on fees, and that over the long term of a pension’s life, that made a bigger difference than any clever bells and whistles about manager selection.

For fund managers, though, it raises some interesting questions: how to provide a good product at a low fee and still make a margin; and how active management can fit into that. We look more at the allocation question in article five.

Another lesson of a mature market is that just because investors have choice doesn’t mean they use it. Despite the choice of super initiative, it is estimated that about 80% of superannuants in Australia use the default option of their fund, even though they have enormous alternative choice both within and beyond their existing provider. This is another point that underpins the MySuper idea. The lesson for Asian product manufacturers is: get the plain and simple default product right above all else.

Another shift that happens in a more mature market is that more and more assets in the system are post-retirement, as retirees see the sense in leaving their money in pensions rather than withdrawing it all when they can. An ageing population exacerbates this trend: Australians are living longer, need their retirement funds to last longer too, and so are leaving their assets in place for longer. This, in turn creates a source of product development – particularly in a high-regulation place like Australia. Post-retirement products are one of the most vibrant areas for product manufacturers.

This, too, will become increasingly relevant over time in Asia as life expectancies rise with growing wealth and wider availability of better medical care. A boom in post­-retirement assets is clearly some way off – we need the boom in pre-retirement money first – but Australia tells us that this is eventually where we end up.

It’s interesting that this is happening in Australia, though, since we are now at the point where the baby boomer generation, which is the real meat of the national population, is ending its working life and entering retirement. This should be the point when superannuation balances start declining as they enter retirement. But we’re not yet seeing that happen.

Article 4: structure

The Australian pension fund industry offers a useful counterpoint to many contemporaries in Asia. Even in advanced Asian markets such as Korea, one pension fund – the NPS – is utterly dominant. Countries with more emerging asset management industries seem to be following the same model: in Malaysia, the Employee Provident Fund is by far the most powerful institution in the country.

Australia doesn’t just have a lot of pension funds, but a lot of different types of pension funds. Based on the most recently available data from the Australian Prudential Regulatory Authority, accurate to September 30, the retail part of the market – commercial fund management groups offering super funds – account for $351.8 billion of assets; industry funds – not-for-profit funds which have their roots in particular Australian industries, such as healthcare or the automotive sector, but which can now be offered to the broader Australian public – $241.9 billion; public sector funds $195.2 billion; and corporate funds, where a company offers its own super fund, $54.6 billion. Bigger than all of these, though, are self-managed super funds: those run by individuals on their own behalf. They account for $397.2 billion, accounting for 31.1% of all superannuation assets.

Behind these figures are a number of trends, several of which date back to the opening of the market to the choice of super program in 2005. Since then, industry funds – having been opened to a wider audience – have grown dramatically, from $94 billion in 2004, with aggressive marketing campaigns based on their ‘no-profit’ credentials and seeking to take market share from retail funds. Corporate funds have been shrinking ever since, and will continue to do so – assets dropped 8.6% in this area in the September 2011 quarter alone – because choice of super brought with it a host of compliance requirements that make it prohibitive for all but the largest corporations to run their own super funds. It’s far better for most to instead point members towards an external default fund.

The growth in self-managed super represents surely the most remarkable story. There were 450,498 SMSF funds in Australia as of September 2011, according to APRA, and they appear to be on track to represent half of the industry.

Their growth can be attributed to a number of things, including a belief that individuals can do as well as professionals. (Another way of looking at it, in recent difficult times, is: “If I’m going to lose money, I might as well do it myself.”) Another significant impact has been a change in the law allowing people to acquire a property within a self-managed super fund, with banks lending up to 80% of the cost. This has had the effect of increasing the amount of money investors have with which to launch a self-managed fund, albeit much of it leveraged. And a third prompt has been the sheer ease of investment in Australia: it is one of the countries with the highest levels of individual share ownership in the world, prompted by privatizations and demutualisations of groups like the Commonwealth Bank of Australia, Telstra and AMP, so pretty much everyone therefore has a broker, usually online. Investment platforms make it increasingly easy to access mutual funds across a range of asset classes and geographies, while the growing range of available ETFs (see chapter five) make passive investment, and investment in commodities, increasingly straightforward. Australians have access to a vibrant financial press and are considered very savvy about personal finance.

However, the growth in SMSFs has become alarming, to a degree, with some concern that people start funds without sufficient assets to make them practical, without sufficient skill, or – this is increasingly common – without an understanding of the administrative skills that are required around legal, compliance and accounting issues. The ATO is paying more and more attention to these funds and to ensuring that people really do know what their obligations are. An ATO audit of your super fund is such an unlovely experience that some groups have started offering insurance against the disruption and cost they cause.

Deloitte predicts that SMSF assets will reach $2 trillion by 2030, compared to about $1.5 trillion apiece for industry and retail; but it argues that it could have been bigger still. Deloitte had previously said SMSFs could have been worth $3 billion by that time except for the government introducing lower concessional contribution limits. This is another example of the peril of long-term predictions in Australia: so frequently do the rules change, it’s hard to look too far ahead.

While the volumes in superannuation reach ever higher, the number of funds themselves may decline, in a process of consolidation matching that in the advisory space. Rice Warner Actuaries, for example, projects that superannuation assets will hit $3.3 trillion by 2026, but the number of super funds will drop by 48% in the next five years. How so? Partly, this is a consequence of corporate funds (of which there were 143 as of June 30 2011) closing down, with Rice Warner predicting only 35 left standing in five years; but partly it’s through mergers, a process that has already been in evidence for some time. In early 2011 five industry fund mergers were underway at the same time: First State Super with Health Super, AustralianSuper with Westscheme, LGSuper with City Super, Equip Super with Vision Super, and Non-Government Schools Superannuation Fund with Cue Super. On the retail side, mergers at a senior level – Westpac with St George, for example, or the sale of Axa businesses in Australia, or ING’s sale of its half of the OnePath business to ANZ – can also have knock-on effects for underlying super funds.

In light of this, and in expectation of it continuing, RiceWarner expects the number of industry funds to drop from 65 to 42, and commercial (or retail) from 141 to 95. For smaller funds, it is argued, it simply won’t be possible to compete in this environment of legislative change, market turmoil, and the competitive threat of self-managed funds. Scale will matter, and merging will get them there.

This is not always straightforward. Russell Investments launched a paper in August arguing that the cost efficiencies and economies of scale from mergers were not necessarily serving the best interest of fund members. The paper wrote of the importance of ensuring member equity in addressing differing exposures to liquid and illiquid assets between merging funds, for example, as well as managing transparency and accountability principles that may differ from fund to fund.

Could a similar evolution take place in Asia? We are a long, long way away from a pension fund looking anything like Australia’s in any ex-Japan Asian market. But a natural evolution would involve, first, a greater diversity of funds permitted to handle the pensions of investors; more corporate pensions, as is happening in China, for example; then greater member choice in the handling of their pensions.

Outside the pension fund industry, Australia’s investment management looks much like the rest of the developed world; the distinctions are more on the distribution side, outlined in chapter 2. Australia hosts a highly specialised and sophisticated industry with, for example, very clearly defined niches in areas such as small cap equities, listed property or resources. It hosts a range of international managers, and a buoyant alternative segment, with many hedge funds and private equity funds available, often through fund of fund models. It is also noted for the popularity of balanced funds.

On this retail, non-pension side, Asian markets are already increasingly resembling Australia: specialization and segmentation are well underway in markets including Hong Kong, Singapore, Korea and Malaysia, for example. Australia does, though, demonstrate something that Asian fund managers probably already know: no matter how clever and esoteric the varieties – the high yield credit funds, the single country funds, the soft commodities or private equity or infrastructure plays – the fact is that the bulk of the money goes into the funds that people can readily understand, and nowhere more so than plain old large cap domestic equities.

Fee pressure is a fact of life in Australia today, as in any mature fund management market. Australian fund managers have, in recent years, become more widespread users of performance fees, although they seem somewhat out of favour in the new low-fee drive of Australian regulation. In Australia, performance fees went through a clear evolution. Some early products had preposterous arrangements in which managers would be rewarded for positive performance but with no penalty for negative ones. Swiftly, a high water mark became the norm, through which managers would have to recoup any previous losses before any new performance fee could be applied. It is also more common for a performance fee to be levied on outperformance over a benchmark, rather than any positive performance. This remains the norm today.

5. Models and product

Australia hosts a range of models within the fund management industry, from boutique fund managers and individual financial planners, through to groups that integrate financial services businesses through the value chain and employ thousands of people.

One group that appears to be set to benefit from regulatory change is the vertically integrated approach: one that combines banking, funds management, financial planning and maybe even insurance, with synergies and cross-selling between them. So, for example, the Commonwealth Bank of Australia is also the owner of Colonial First State, one of the largest fund management groups in Australia (and owner of some of the biggest investment platforms); Count Financial, the largest network of professional accountant-based advisers; and CommSec, one of the leading online brokers. BT, which on Plan for Life’s numbers is the biggest player in the masterfund (platform) industry, and a leading fund manager, is part of the banking group Westpac; OnePath is linked with ANZ; and MLC is part of National Australia Bank. Outside the big four banks, AMP, a leading fund management, superannuation and insurance group, has the biggest set of aligned financial planners in Australia and owns the planner group Hillross; and Axa combines insurance, superannuation and investment with 1300 financial advisors, also fitting the vertically integrated approach.

We are likely to see more consolidation vertically in coming years, creating a barbell effect: groups that offer everything on one side; specialist, independent, boutiques on the other. For the moment, anecdotally, many IFAs are seeking to join these big vertically integrated groups in order to benefit from their scale and synergy.

Most of the bigger institutions have their own investment management capability and offer a range of mutual funds across most asset classes, as well as balanced options and superannuation funds. But the platforms then give access to a host of other managers – the open architecture model is the norm. Many of the bigger fund managers, most notably MLC, are known advocates of multimanager models, which bring together a range of underlying investment managers into a single blended portfolio for investors.

It’s interesting to look at how Australians invest. APRA is considered the most useful source within the superannuation industry, although the last report of this kind, issued in 2011, was based on holdings in June 2010. Then, across the default options of super funds with more than four members (that is, not self-managed funds), the average was to have 29% in Australian shares, 23% in international shares, 3% in listed property, 7% in unlisted property, 10% in Australian fixed income, 6% in international fixed income, 9% in cash and 13% in other assets (chiefly alternatives). There are some variations; industry funds are known for their preference for unlisted alternative assets like infrastructure, and so ‘other’ accounts for 18% of their allocation and unlisted property a further 10% – but generally the position is quite representative.

Self-managed super funds appear to exacerbate these extremes. Those who look at SMSFs say they often have virtually nothing offshore, and a heavy concentration on the top 20 domestic stocks alongside direct property – often a business property which is then leased back to the fundholder. The most reliable data on SMSF allocation is produced by the Australian Taxation Office, but an update would be useful: the last stems from 2009 data.

It’s harder to keep track of how Australians invest outside of superannuation, but they are generally considered very heavy on equity allocations, and overwhelmingly domestic. A typical model of 70/30 growth/defensive assets had become the norm for many investors running up to the financial crisis. A great deal of money has moved to the sidelines in recent volatility, chiefly just into cash, but it would be no surprise in brighter times to see a return to roughly the same growth-chasing model that existed beforehand. It’s worth noting that Australian blue chips typically offer a high dividend yield – many of them around 6%, with tax advantages besides – which perhaps gives them a more defensive nature than might be the case with top stocks in, say, the US or Hong Kong.

What will MySuper mean for allocations? With a target of a 1% fee – not yet required by legislation, but an accepted rule of thumb for what a MySuper product ought to charge – it’s likely that these funds will be commoditised and rather similar in appearance. Many product manufacturers expect them to have a roughly 70% allocation to growth assets, just as other super funds have typically done, but it is almost inevitable that a large part of the assets will be invested passively, through funds and mandates, to keep fees down, with some active positions around the edges.

The shift to passive allocation would be in keeping with a trend in that direction in recent years anyway. For one thing, index funds tend to gain market share in tough market conditions, since many active managers underperform when things are tough and there is a sense of safety in owning a broader market that will one day, inevitably, recover. The arrival of dozens of new ETFs in the recent years – after nearly a decade when there were only a handful, all from State Street – has also brought much greater attention towards passive strategies. Today, there are 60 ETFs listed on the ASX, becoming increasingly specialist with every new launch; recent ones have included agricultural commodities, currency ETFs for the euro and sterling, and Australian mining. A recent agreement between industry, the Australian Securities and Investments Commission and the ASX also paves the way for fixed interest ETFs to be launched in Australia – until now the missing piece of the market – and as many as 10 are expected to appear during the second quarter of 2012.

Part of the reason for this new popularity is the change in remuneration structures: planners always used to be reluctant to recommend ETFs, since they carried no trail fee, but as the industry has moved to a fee for service model they have started to see the benefit in a low-cost index approach to bring fees down. The core-satellite approach is becoming increasingly commonplace.

Still, they’re not that entrenched; the combined market cap of the 60 ETFs in January 2012 was A$5.1 billion, compared to a total market cap of the entire ASX of well over a trillion dollars. But the trend is inarguable, and the market loves the low fees.

On the wholesale side, Australian fund managers have a variety of institutions from whom they can seek mandates, chiefly the super funds themselves, although it is notable that several of those are trying to build their in-house expertise. This can take two forms: staff who can handle the passive business internally, or the other extreme, which is specialists in unlisted asset classes such as infrastructure. The Future Fund is representative in this respect: many of its earliest hires were specialists in infrastructure, forestry and other alternative asset classes involving direct investment and a very long-term time horizon. The outsourcing then takes place in more mainstream asset classes like equities and bonds.

One industry fund, SunSuper, took a different approach by buying a stake in a private equity fund rather than trying to get allocation in that manager’s funds. Industry funds, generally, are considered much more willing to invest in unlisted asset classes – in some cases, like Westscheme and MTAA, as much as half the fund – although this did cause alarm during the financial crisis when illiquidity became an issue, and it continues to create challenges for accurate performance evaluation.

On the product side, Australia is less of a trailblazer for Asia than in distribution and pensions; many of the trends here are already well underway in sophisticated Asian markets like Hong Kong. And in terms of overall model the vertically integrated approach, from bank to fund manager to advisor to platform, looks in some ways like the do-everything model of big Korean institutions, suggesting that oddly Australia is reverting to a more old-fashioned approach. Often an industry’s maturity means ending up somewhere it has already been along the way.