Super ideas to manage money

By Tony Featherstone

When it comes to share investing, most investors buy shares directly or use managed funds. Less considered are separately managed accounts (SMAs), an increasingly popular investment structure and service that overcomes typical challenges with shares and managed funds.

Think of SMAs as a half-way house between shares and funds. Like shares, an SMA lets you maintain direct beneficial ownership of your investment portfolio. And like a managed fund, the SMA has a fund manager who decides what to buy and sell, in accordance with a set investment strategy. Every investor in an SMA program owns the same company shares based on a model portfolio.

Wealthier investors who want more personalised service can choose an individually managed account (IMA), which is a deluxe version of an SMA. The main difference is IMAs do not take a one-model portfolio approach to investing, where all participants own the same shares. IMAs are tailored to individual circumstances. It is like having your own personal fund manager.

Then there is the newer concept of unified managed accounts (UMAs), which enable investors to hold different types of investments in their accounts. For example, a farmer might hold shares, property, precious metals and even valuable animals, such as bulls or racehorses, in their UMA. UMAs also suit wealthy investors who want to combine all their investments in one place and have a professional investment manager oversee them.

(Editor's note: Don't miss the ASX Self Managed Super Roadshow - taking control of your retirement savings later this month. Places for this free event are limited, so be quick to register your attendance for the event, or to receive and discuss the material via an ASX webinar.)

How they work

Consider an investor, Frank, who has a $500,000 portfolio consisting of 20 blue-chip shares. Frank is tired of deciding what shares to buy and sell, and feels his stockbroker only gives him buy ideas and never tells him when to sell. Frank has also had a bad experience with managed funds; he received an unexpected capital gains tax bill from one fund last year.

Frank has a meeting with one of several investment firms that offer SMAs. The firm looks at how Frank's portfolio compares with its own SMA model portfolio. Frank has eight shares that are also in the model portfolio. They are transferred to the SMA and Frank's remaining 12 are sold (possibly triggering a capital gain or loss). Frank now has $500,000 invested in the SMA's model portfolio, which is run by professional managers who watch his money every day.

Unlike a managed fund, which pools investments, Frank still has beneficial ownership of the shares. His investment is not affected by the actions of other investors in a managed fund, which can sometimes create unexpected tax outcomes or force fund managers to sell shares to meet redemptions as other investors leave the fund. His portfolio is more transparent than a managed fund - Frank knows exactly what he owns and when his shares are bought or sold.

Frank pays fees of between 0.7 per cent and 1.6 per cent of funds invested (depending on the SMA manager). He receives a quarterly statement outlining his investment, and an annual statement. Best of all, Frank has a professional manager thinking about issues, such as portfolio construction and maintenance, asset allocation and share selection.

Frank has only ever thought about picking shares, even though sound portfolio construction and asset allocation are more important in the long run. He does not have the skills to properly construct and maintain a well-diversified portfolio on his own.

A few years later, Frank's portfolio is worth $650,000. He also has $800,000 in a self managed super fund (SMSF) and another $250,000 in cash. He is happy with his SMA, but wants more personalised service now that his investments are worth more than $1.7 million.

By choosing an IMA, Frank has his own personalised fund manager who can manage his investments. He no longer invests in a model portfolio that all participations in the SMA program use, but rather a portfolio tailored just for him. IMA fees are higher than an SMA, but still very competitive against retail managed funds.

What the experts say

ASX Investor Update asked two leading firms that offer SMAs, IMAs or UMAs about the features, benefits and risks of this investment structure.

Andrew Tracy
Executive Director, Investment Services
JBWere

The main advantages of SMAs are professional portfolio management, more consistent tax outcomes than managed funds, lower fees than retail managed funds, and access to strong investment research.

On the first point, I have seen too many investors with portfolios full of 'cocktail stocks'. That is, they own all these shares their financial adviser or friends recommended they should buy, but never sold them. These investors have never really thought about correct asset allocation in their portfolio, or rebalanced portfolio weightings as market circumstances dictate.

With an SMA, investors get a well-designed, well-structured model portfolio and automatic monthly rebalancing where investment professionals buy and sell the best shares that meet the SMA's strategy. Turnover in our SMA model portfolios is usually fairly low.

Having direct beneficial ownership of shares in an SMA is also a big advantage. When you invest in a managed fund, you may be exposed to embedded capital tax gains that result from investment decisions before you joined the fund. This is one of the biggest downsides of pooled investing.

Also, dividends in a managed fund go back to the fund to be reinvested in other shares or distributed to unit holders, at the fund manager's discretion. With an SMA, dividends go to the investor's individual cash account, and the dividends can be withdrawn at the investor's discretion or reinvested into the fund at the next rebalance date. Our SMAs are cheaper than retail managed funds, which makes a big difference to returns, especially in long-term vehicles such as self-managed super funds.

When choosing an SMA provider, look at people, process, price and performance. Choose firms that have been around a long time, have excellent research teams, good SMA performance over a long period, and competitive fees.

The main risk with an SMA is that the provider's model portfolio underperforms the market.

Kris Vogelsong
Head of Corporate Development
Private Portfolio Managers

We offer IMAs to people who have at least $1 million to invest. The main advantage of an IMA is personalised service: it really is like having your own personal fund manager. Some clients come to us with portfolios that contain 10 years of buy recommendations that no longer suit their investment needs or goals. Nobody has advised them on asset allocation and portfolio rebalancing - issues that good fund managers think about every day. Their portfolios are a mess.

Also, IMAs typically hold 25 to 35 companies. A retail managed fund may hold more than 50. This concentration in IMAs provides potential for higher returns while maintaining appropriate diversification. Managed funds that hold larger numbers of companies may produce returns that more closely match their underlying benchmark index, which is not a good result for unit holders who are paying higher fees for funds to outperform the market. Investors who are happy with just the index return are better off buying low-cost, exchange traded funds (ETFs).

Tax is also a very important consideration with IMAs. I doubt enough investors realise that when they buy units in a managed fund they may end up paying tax for somebody else who has left the fund. Or that they may receive a capital loss from the fund when they have no capital gains to offset it against for several years. This occurs because all investors in the fund share capital gains or losses, even those where tax outcomes may relate to investment decisions made well before they joined the fund.

I have seen research in the United States that shows how tax inefficiencies with the unit trust structure reduce fund performance by 2 per cent on average each year. This is a very high cost in the long run. IMAs provide much better tax outcome and offer more tax flexibility. Investors can work with their IMA manager to choose an investment style that best matches their tax circumstances.

I also think wealthier investors appreciate the transparency and privacy that comes with IMAs. When you invest in a managed fund, you get what everybody else in the fund gets and it can be difficult to understand exactly what the fund is buying and selling. With IMAs, direct beneficial ownership of the shares remains with you, and only you and your IMA provider know what is in the portfolio. We have had a number of clients with self-managed super funds use the IMA structure to manage their funds.

Like any actively managed investment, the main risks with IMAs is portfolio underperformance. Also, there is much less information about SMAs, IMAs and UMAs, compared to managed funds. They are not tracked and compared to the same degree that managed funds are.

It is important that investors think about the right investment structure when they invest - not only what to buy and sell. All investment structures have their pros and cons. Choosing the right structure can create a huge difference in areas such as tax and fees. For long-term investors, getting a few extra percentage points in their annual returns can multiply into significant gains.

About the author

Tony Featherstone is a former managing editor of BRW and Shares magazines, and is consulting editor of ASX Investor Update.

From ASX

Self-managed super is still the fasting growing sector of superannuation in Australia. With the release of the Henry Tax Review and the recent Federal Budget, now is the time to not only look at how you might set up your own SMSF but also, if you are an existing trustee, to reassess the systems and processes you use to manage and maintain your fund.

Attend the free ASX SMSF roadshow later in June to learn more. This roadshow consists of two sessions:

1.  Intro to SMSFs - covers the needs of investors planning to start an SMSF or for existing trustees to reassess the systems and process in your existing fund.
   
2. SMSF strategies - how ASX listed products can help provide diversification, generate income, and provide capital growth.

Attendees are invited to register for both sessions or select the session that best meets your needs. The roadshow is available via webinar for those investors who can't attend an event.

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