Money Management (September 15, 2011)

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Vol.25 No.35 | September 15, 2011 | $6.95 INC GST

The publication for the personal investment professional

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LENDERS ACCUSE SHORTEN OF SET OUTCOME Page 4 | NEGOTIATING THE NEW NORMAL: Page 18

Equal scrutiny urged on group mandates

By Mike Taylor CORE elements of the financial planning industry are calling for greater regulatory scrutiny of the contractual arrangements underpinning the multi-million dollar group insurance mandates negotiated by superannuation funds.

A Money Management investigation has confirmed that the negotiation of some of the largest group insurance mandates in the superannuation industry have involved both ‘profit sharing’ arrangements and ‘rebates’ which have flowed back to the superannuation funds and which are not always reflected in the Member Expense Ratio.

Money Management understands the rebates are most often based on the difference between the premium actually paid

by the superannuation funds and the cost of claims in any given year, with some arrangements providing for a guaranteed percentage return to the fund.

Some of the larger group insurance mandates have seen superannuation funds paying premiums in excess of $100 million in one year, meaning that profit sharing or rebate arrangements are calculated in millions of dollars a year.

Considerable differences exist between mandates, with some superannuation funds opting not to pursue such deals.

While comparisons have been drawn between the commercial structures surrounding group insurance and the volume rebates paid in the financial planning industry, it is being argued that the group insurance rebates and profit share

Planners shift to passive investments

By Tim Stewart PLANNERS are increasingly recommending passive investments to their clients, but there is debate about the reasons behind the move away from active strategies.

Wealth Insights managing director Vanessa McMahon said there had been a marked shift away from active to passive over the past four years.

“As an indication of the move to index funds, twice as many advisers now place business with Vanguard than in 2007 ... Likewise, many advisers have begun using passive [exchange-traded funds],” McMahon said.

For Morningstar co-head of fund research Tim Murphy, the market downturn heralded by the global financial crisis (GFC) only partly explains the move by advisers towards passive investments.

He pointed to recent Morningstar research conducted in the US that looked into the outflows from equities funds beginning in mid2008, coupled with inflows into big fixed interest and bond funds like PIMCO. The research concluded that the “dramatic change in the way advisers were compensated (commissions versus fee-based) [was] driving the switch to passive”.

Murphy said the ban on commissions and subsequent move Continued on page 3

arrangements cannot be compared to the volume rebates because they are usually based on a return of excess premium.

However, both the Financial Planning Association (FPA) and the Association of Financial Advisers (AFA) are arguing for a level playing field and greater transparency.

FPA chief executive Mark Rantall said his organisation had accepted the removal of conflicted remuneration structures and greater transparency, and this should occur in equal measure with respect to superannuation.

“Superannuation fund members should have equal rights with other consumers, so there should be total transparency with respect to commercial arrangements and

Mark Rantall

Continued on page 3

RESPONSIBLE INVESTMENT

Ethics equal good risk management CONSIDERING ethical values in investment decision-making is increasingly being seen as an effective method for minimising investment risk and has been gaining traction over the past couple of years.

Recent corporate scandals such as the News Limited affair, BP oil spill and Tepco nuclear disaster in Japan have suddenly put a spotlight on responsible investing, with institutional and high-net-worth retail investors leading the way.

Regardless of client demand, financial planners now have new factors to consider when recommending certain investments – such as the impact of climate change and rising sea levels – which creates demand for more education around this financial discipline.

The highly discussed carbon tax has also politicised the debate around responsible investments, which industry participants say can only have a positive impact on the sector.

To read more on trends in responsible investments, turn to page 14.

Editor

Reed Business Information Tower 2, 475 Victoria Avenue Chatswood NSW 2067 Mail: Locked Bag 2999 Chatswood Delivery Centre Chatswood NSW 2067 Tel: (02) 9422 2999 Fax: (02) 9422 2822 Publisher: Jayson Forrest Tel: (02) 9422 2906 jayson.forrest@reedbusiness.com.au Managing Editor: Mike Taylor Tel: (02) 9422 2712 mike.taylor@reedbusiness.com.au News Editor: Chris Kennedy Tel: (02) 9422 2819 chris.kennedy@reedbusiness.com.au Features Editor: Milana Pokrajac Tel: (02) 9422 2080 milana.pokrajac@reedbusiness.com.au Journalist: Tim Stewart Tel: (02) 9422 2210 Journalist: Andrew Tsanadis Tel: (02) 9422 2815 Cadet Journalist: Angela Welsh Tel: (02) 9422 2898 Melbourne Correspondent: Benjamin Levy Tel: (03) 9527 7392 ADVERTISING Senior Account Manager: Suma Donnelly Tel: (02) 9422 8796 Mob: 0416 815 429 suma.donnelly@reedbusiness.com.au Account Manager: Jimmy Gupta Tel: (02) 9422 2850 Mob: 0421 422 722 jimmy.gupta@reedbusiness.com.au Adelaide Agent: Sue Hoffman Tel: (08) 8379 9522 Fax: (08) 8379 9735 Queensland Agent: Peter Scruby Tel: (07) 3391 6633 Fax: (07) 3891 5602 PRODUCTION Junior Designer/Production Co-ordinator – Print: Andrew Lim Tel: (02) 9422 2816 andrew.lim@reedbusiness.com.au Sub-Editor: Marija Fletcher Graphic Designer: Ben Young Subscription enquiries: 1300 360 126 Money Management is printed by Geon – Sydney, NSW. Published every week, recommended retail price $6.95 Subscription rates: 1 year A$280 incl GST. Overseas prices apply.

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Employing hired guns

R

etaining reputable research and surveying companies to undertake a project to a specific brief is not an inexpensive exercise. Companies such as Newspoll, Roy Morgan, Rice Warner and even Rainmaker do not come cheap.

In the past four years, the Industry Super Network (ISN) has used each of the aforementioned research and surveying organisations to undertake projects the results of which have been utilised in prosecuting the ISN’s agenda with respect to the financial planning industry.

On each occasion, once the research results have been provided to the ISN they have been disseminated to the media and various industry stakeholders in a fashion which has, more often than not, caused a good deal of consternation in the financial planning community.

Such was the case last week when ISN chief executive David Whiteley used research his organisation had commissioned from Rainmaker to claim $3 billion was paid in commissions by retail superannuation fund members last year – something which would justify the Government legislating to tip them all into no-commission MySuper arrangements.

Putting aside the aggravation inflicted on financial planners, the ISN’s expenditure on research and the statements thereafter

2 — Money Management September 15, 2011 www.moneymanagement.com.au

“

The reputation of the research or surveying company delivers an aura of credibility, while a close examination of the findings speaks volumes about the brief to which they worked.

”

issued by Whiteley have to be seen for what they really are – the transfer of long-standing political campaign techniques to the financial services arena.

The strategy of commissioning highly specific research from reputable companies and utilising it to underpin a particular agenda has been the stock in trade of lobbyists and political operatives for decades. The reputation of the research or surveying company delivers an aura of credibility, while a close examination of the findings speaks volumes about the brief to which they worked.

The cost of such exercises normally limits the degree to which they are utilised. The number of times the ISN has commissioned such research suggests it feels no such financial constraints.

If it costs a good deal of money to commission the research, then arguably, it can cost both time and money to appropriately counter the conclusions which are then reached. Take, for instance, the recent Roy Morgan (Retirement Planning Report) commissioned by the ISN which stated that 72 per cent of retail super fund members did not have regular communication with their adviser and asserted that “the vast majority of these members are likely to be paying ongoing advice fees or commissions”.

It might have been counter-argued that these findings are misleading, simply because advice sought and fees paid are discretionary and contemporary retail products such as BT Super for Life, Colonial First State’s FirstChoice, and AMP Flexible Super do not have commission structures.

Those who closely examined the Rainmaker research might just as easily have pointed to the fact that had the scope of its research been extended, it might have referenced the manner in which industry funds were remunerated when large group life insurance mandates are awarded.

Research and surveying companies are like barristers. They carry out their task consistent with their terms of engagement and a brief dictated by their client.

– Mike Taylor

News Equal scrutiny urged on group mandates

AFS works with AIOFP on MDA

Continued from page 1

AUSTRALIAN Financial Services (AFS) will launch a private label managed discretionary account (MDA) next month which it says is aimed at driving down costs and increasing control over their business in preparation for the Future of Financial Advice (FOFA) reforms.

AFS is working with the Association of Independently Owned Financial Planners (AIOFP) on the launch of the MDA and will offer it to AIOFP members, AFS managing director Peter Daly said.

The group is using Investment Administration Services as the administrator and licensee to allow AIOFP members to use an independent license, while OneVue will be offered to AFS advisers, Daly said.

AFS will also negotiate institutional pricing to drive down costs, Daly said.

payments within group insurance mandates,” he said.

AFA chief executive Richard Klipin echoed Rantall’s sentiments on the need for a level playing field, and said it was time to acknowledge that superannuation represented one of Australia’s largest industries, involving significant commercial arrangements.

“The financial planning industry has been subject to demands with respect to transparency, and in the interests of a level playing field that needs to be extended to all sectors of the market,” he said.

Rantall said he believed total transparency was required across the financial services industry, and that this needed to be equally applied to profit share or rebate arrangements with respect to group insurance.

Planners shift to passive investments

By Benjamin Levy

A number of dealer groups were moving to private labels in response to FOFA, showing that the future of the industry was in private labels, he said.

AFS is working with an asset consultant, Ibbotson Associates, to signoff on the portfolios and corporate governance, according to AFS head of strategic development Meaghan Unsworth.

“The key is to ensure that we have flexibility and control and risk management given the current environment.

But we know that advisers are moving this way anyway; their clients are looking for greater transparency and beneficial ownership of stocks as well,” Unsworth said.

Advisers who want to increase their portfolio construction within the MDA will need to have a certain level of accreditation and knowledge, according

Meaghan Unsworth to Unsworth. The accreditation process will be centred around products, and will also involve a knowledge of how the MDA structure works.

AFS already has a private label selfmanaged super fund solution.

Continued from page 1 towards fee-for-service in Australia would see passive investments continue to be favoured by advisers.

But Boutique Financial Planning Principals’ Group president Claude Santucci rejected the notion that fee-for-service was having a significant effect on planner attitudes.

“I don’t think it’s got anything to do with fees, commissions and all that – I think that’s a complete furphy. It’s simply a reaction to the concerns people have about the GFC, which is still ongoing,” Santucci said.

One planner who has moved over to a fee-forservice business model is Affinity Private principal Catherine Robson, who says she uses an index approach as the core of her investment offering.

“It’s illusory to pretend that you can consistently predict short-term movements in markets, or that there are many fund managers that can consistently outperform the index,” Robson said.

Robson said the most important thing for her was her value proposition.

She said it made sense for her clients to have a large amount of their portfolios exposed to the index at a very low cost, because then she could focus on her clients’ long-term financial goals without either party having to worry about short-term market gyrations.

Vanessa McMahon She also said the introduction of a fiduciary duty would give planners an extra incentive to conduct thorough due diligence before they “engaged in something a little bit outside the norm”.

FinaMetrica director Paul Resnik said that in his conversations with planners, there was recognition that in any business model that relies on recurring customers, the biggest challenge was managing client expectations. The best way to remove that risk was to offer clients passive investments, he said.

“Generally it’s the brighter [planners] who have put all this together, and they’ve figured out that markets are really unpredictable, and some managers are even more unpredictable,” Resnik said.

McMahon agreed that unpredictable fund managers were a risk for planners.

Clients were telling planners that market risk was acceptable, but that product risk was not, she said. www.moneymanagement.com.au September 15, 2011 Money Management — 3

News Lenders accuse Shorten of pre-determined outcome

By Mike Taylor THE National Financial Services Federation has strongly urged the Government to enter into further dialogue around its new National Consumer Credit Protection legislation amendments, arguing that key elements have been distorted by the media and consumer advocates.

As well, the Federation has accused the Assistant Treasurer, Bill Shorten, of seeking to pre-determine an outcome and of providing an inappropriately short consultation period.

In a submission filed with the Government, the

Federation has claimed the proposed legislative amendments will have unintended consequences which could leave up to 500,000 consumers “financially excluded from credit”.

The submission described the 500,000 as being a separate group of consumers who had not been recognised in the reform process to date.

“As this group of consumers is not considered vulnerable or disadvantaged, they do not qualify for one of the alternatives quoted by the Minister,” it said. “At the same time, they can not access small amount short-term credit via the mainstream banking system.”

The Federation claimed the Government’s legislation would effectively remove a key sector of the industry, and the void would be filled by unlicensed and unregulated operators – effectively exposing consumers to more risk.

The submission claimed the demand from the estimated 500,000 consumers would not go away, and moved on to suggest their exclusion had been the result of a process to date that had lacked clarity and had often been the subject of confusion.

It said this had “allowed the media and consumer advocates to paint a picture that is not representative of the small amount short-term finance market”.

Bill Shorten

Plan B to look at product – not just advice

By Milana Pokrajac TA RG E T I N G g row t h i n financial advice will not be the only focus for Plan B, according to the dealer group’s newly appointed chief executive of ficer, Andrew Black.

Black said the group saw upcoming regulatory changes as an opportunity, rather than a threat, which he believes will help Plan B expand its market presence.

“Plan B has got multiple business lines in there, and diversification will be a key component in the upcoming changes – we’ll have to look at the product as well, rather than being just service oriented,” he said.

Black – whose appointm e n t wa s r e c e n t l y a n n o u n c e d by P l a n B chairman Bryan Taylor – will mainly focus on growi n g t h e We s te r n Au s t r a l i a n d e a l e r g ro u p .

Black said he already saw a number of opportunities after the release of the Future of Financial Advice draft bill. “ P l a n B h a s a l way s been fiduciary certified and fee-for-ser vice, for example, and for them it’s business as usual,” he added. “My job is capitalising on the opportunities that are in there a n d to r e a l l y l o o k a t being able to get some genuine growth out of the organisation.”

Black, who will officially start with Plan B on 19 September, was most recently head of Skandia Australia when it was part of the global Old Mutual Group.

4 — Money Management September 15, 2011 www.moneymanagement.com.au

News

Balance sheet repair trumps higher SG

By Chris Kennedy THE Coalition will have to repair the nation’s balance sheet before it can address several key issues facing Australia’s superannuation system, according to Shadow Financial Services Minister Mathias Cormann.

If it returns to power at the next election, the Coalition won’t have much room to move in the short-term because the budget is in such bad shape, Cormann told the Small Inde-

pendent Superannuation Funds of Australia (SISFA) conference last week.

Cormann was speaking immediately after a presentation by Assistant Treasurer and Financial Services Minister Bill Shorten, in which Shorten questioned how the Coalition would boost national savings if it continued to oppose a phased increase in the superannuation guarantee (SG) from 9 per cent to 12 per cent.

After also reiterating the likely changes to the self-managed super

fund sector from Stronger Super changes, and answering several questions from the floor regarding the Government’s intentions around raising the concessional contributions caps, Shorten immediately left the conference.

“Thank you to SISFA for bringing Bill Shorten and I together in one room – even though he’s again missed the opportunity to hear what the Coalition’s views are on superannuation policy. I’m sure the day will

come,” Cormann began.

He then added that the Henry review recommended leaving the SG at 9 per cent, and restated the Coalition’s intentions to increase voluntary savings rather than compulsion by making concessional contributions more attractive.

He also expressed a need to urgently address the penalties for inadvertent breaches of concessional contributions caps and find an efficient way to allow people to correct those mistakes.

Mathias Cormann

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netwealth’s new menu

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The platform had also reported $450 million of net flows for the 2011 f i n a n c i a l y e a r, w h i c h Heine deemed satisfactory considering the volatile market. netwealth will continue to use ’Standard & Poors Fund Services as its provider of managed funds research, but has announced a number of other changes to come through in the coming months.

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www.moneymanagement.com.au September 15, 2011 Money Management — 5

News

AFS streamlining APL

By Benjamin Levy AUSTRALIAN Financial Services (AFS) is reviewing its approved product list (APL) with a view to dumping unproductive or unsupported products and platforms.

Lonsec, which is in charge of the review, will report back late this month or early next month.

The review is being conducted together with the dealer group’s financial planners. The group executive is trying not to be too proscriptive on the type of products the dealer group retains, AFS managing director Peter Daly said.

AFS currently has a wide APL. “The future needs to be a more limited product selection, and we want our planners to work with us at determining what that looks like,” Daly said.

Peter Daly

Products that are no longer supported by the AFS’s advisers will be the first to go, he said.

AFS’s new head of strategic development Meaghan Unsworth is working with a strategic development committee made up of AFS’s best 15 practices to nut out a best of breed approach and choose product and platform solutions based on those criteria, according to Daly.

AFS is also planning to upgrade its 12 months old self-managed super fund solution. The group had been “navelgazing” over the past 12 to 18 months because of uncertainty about the group being acquired and it was time to fix up the existing solution, Daly said.

Da l y d i d n’t r u l e o u t c o m p l e t e l y dismantling the solution and building something completely different.

Corporate insolvencies reach “highest ever” figures in 2011

By Angela Welsh 2011 is well on the way to setting a record for corporate insolvencies, according to Dissolve – a business specialising in company liquidations.

“This is more bad news about the state of corporate Australia,” said Dissolve chief executive officer Clif f Sanderson, commenting on the most recent release of insolvency statistics from the Australian Securities and Investments Commission.

S t a t i s t i c s h ave b e e n recorded in the current format since 1999, and 2011 has seen a number of “highest ever” figures.

O ve r 9 0 0 c o mp a n i e s (921) entered insolvency

administration in the month of July 2011. The figure is down from June’s 1,027 insolvencies, but still takes out the title of the highest July ever.

In the year to July 2011, there were 1,355 appointments by secured creditors – the major contributor being banks appointing receivers. “ I n te r e s t i n g l y, the n u m b e r o f vo l u n t a r y administrations, which have the stated purpose of saving a business, is the lowest on a 12 month

basis,” Sanderson said.

“This suggests that we are seeing a lot of companies that have previously c e a s e d to t r a d e b e i n g given their last rights,” he added. The majority of those companies originally struck trouble in global financial crisis part one, Sanderson said.

“We are yet to see the full effect of recent troubles in the retail sector. So we expect that the numbers will continue to be poor through to the end of 2011,” he said.

Basel III to impact bank pricing models

By Chris Kennedy PROPOSED increases in capital requirements for Australian banks could drive changes in the relative pricing of banking products, according to Ernst & Young.

Ernst & Young’s Oceania financial services managing partner, Andrew Price, also said organisations will need to assess how they will continue to create value in the new environment. Wealth management will continue to be an attractive growth option for Australian banks, he added.

Banks seeking to gain a competitive advantage through these reforms will need to link the impacts of the changes to their business processes and technology systems, ensuring they understand the impacts for their customers, people and infrastructure, he said.

PricewaterhouseCoopers partner and banking and capital markets leader, Stuart Scoular, said the long-term impacts are still being assessed, but Australian banks appear to be well placed to meet the APRA’s proposed new rules.

However, smaller authorised deposittaking institutions, such as credit unions and building societies, are likely to feel the impact of the reforms more significantly than the major banks, he said.

Australian Prudential Regulation Authority (APRA) chairman Jim Laker said the proposed Basel III reforms, which require authorised deposit-taking institutions (ADIs) to hold higher minimum levels of better quality capital, supplemented by minimum capital buffers, will enhance APRA’s current prudential capital framework for ADIs. There will also be positive benefits for depositors, other stakeholders and the stability of the banking system as a whole, he said.

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6 — Money Management September 15, 2011 www.moneymanagement.com.au

News

Regulators urged to be more transparent

By Mike Taylor

Senator David Bushby said he would be encouraging other regulatory agencies to follow the example of ASIC, after the financial service and markets regulator said it would publish details of its compulsory information gathering powers on its website, providing an explanation of the nature of its use of coercive powers.

The push for regulators to become more transparent was

AREITs healthier but caution urged

By Milana Pokrajac THE fundamentals of Australian real estate investment trusts (AREITs) are much healthier in 2011 than they were in previous years, but not all investors should re-enter the market, according to Morningstar analyst John Valtwies.

The AREIT sector’s peak-totrough decline of –71.08 per cent between January 2008 and December 2010 was worse than any other asset class, including emerging markets and Australian small-cap resources stocks. However, Valtwies saw AREITs again starting to attract investor interest as the yields hit 6–7 per cent.

“As with any investment, though, it is important to consider an individual’s investment objectives; for income-seekers, a small exposure to this sector is probably a sensible call, but if growth is a more important part of the equation, investors should be looking elsewhere,” he said.

Of the 83 large-cap Australian share strategies Morningstar currently covers, only one – Goldman Sachs – is currently overweight the AREIT sector.

Head of Australian equities at Goldman Sachs Don Hershan re-entered the sector ahead of his peers, but does not own all the stocks and believes there is still a wide gap separating quality attributes such as assets and management.

Meanwhile, Russell Investments research found Australian institutions – which usually set trends for retail investors – currently allocate 9.7 per cent of their investment portfolios to property (largely Australiafocused) and are intending to increase this to 10.5 per cent in two years.

important role to play to ensure our markets and commercial activities operate with integrity and comply with the law – are accountable for their own actions,” he said.

Senator Bushby said he would be encouraging other regulatory agencies to follow suit.

“The public deserves to know the extent of our regulators’ powers,” he said.

FPA0022/MM/PE/J

THE Tasmanian Liberal Senator who found himself at odds with the Australian Prudential Regulation Authority when it declined to answer specific questions regarding its handling of MTAA Super has welcomed a move by the Australian Securities and Investments Commission (ASIC) to offer more transparency.

also pursued by the Rule of Law Institute.

“Ensuring the public has absolute confidence in ASIC using these sweeping powers appropriately is an issue I’ve been pursuing for about three years, and I welcome this development,” Bushby said.

“This is a significant step forward in guaranteeing our regulators – which have an

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www.moneymanagement.com.au September 15, 2011 Money Management — 7

News

Transfer all retail funds to MySuper: Whiteley

By Chris Kennedy ALL retail super fund balances should be transferred to MySuper products from 1 July 2015 to prevent further commission payments being paid where no advice is being provided, according to Industry Super Network (ISN) chief executive David Whiteley.

Referring to Rainmaker research commissioned by the ISN that esti-

mates retail fund members paid an estimated $3 billion in commissions in 2010, Whiteley said it is inappropriate to grandfather commissions paid to financial planners where no advice is being provided.

“The MySuper reforms are intended to address workplace default arrangements where no advice is provided,” he said.

“ISN analysis of Roy Morgan Research suggests more than 2

million Australians are in this boat – paying money for nothing. Where these commissions are being paid on compulsory superannuation and without any financial advice being received by the member, these payments are morally indefensible,” he said.

The $3 billion in commissions in 2010 were split between super investment ($1.9 billion) and group and personal insurance paid for

Investors turn to super funds for help

By Milana Pokrajac INVESTORS are turning to their super funds for help and direction as a third successive year of volatility and poor returns hits their livelihoods, with retirees being hit the hardest.

That is one of the main conclusions drawn from the Investment Trends 2011 Investor Sentiment and Communications Report, which also found investors’ levels of satisfaction with their super funds have started to improve.

Investment Trends principal Mark Johnston said super fund and fund managers had dramatically raised their game over the past four years in keeping members informed about their investments, but added this would no longer be enough.

Johnston said super fund members now want their respective funds to provide them with guidance on future steps, which would require “a combination of good information integrated with effective advice offerings”.

“We think that over the next 12 months

Mark Johnston real differences will emerge between the providers who deliver supportive and costeffective advice framework to help their members through this tough time and the funds who leave members on their own to work it out for themselves,” Johnston said.

Retirees – particularly those with large investment portfolios but lower incomes – are most concerned about the market volatility, according to the report, which surveyed 9,000 Australian investors in May and June 2011.

CONSUMER credit demand has dropped 5.1 per cent since March, the Veda Advantage quarterly consumer credit demand index has revealed. Despite the grim result, demand in the April to June quarter represented a 2.8 per cent rise year-on-year.

The quarter “closes out what has been a very soft financial year for credit demand”, Veda head of consumer risk Angus Luffman said. While the data in the final quarter “reveals some positive trends in certain types of consumer credit” such as personal loans, Luffman said “overall credit demand is still behind on pre-GFC [global financial crisis] levels”.

Credit cards continued to

record weak growth, diving to minus 8.9 per cent – well below the previous March quarter. Year-on-year performance saw credit card demand post its second consecutive decrease of 1.2 per cent.

The drop in credit card demand appeared to be offset by a rise in consumer demand for debit cards, Luffman noted. He cited the impact of new responsible lending laws on banks’ conversion rates and the continuing ‘save not spend’ focus of consumers as contributors to the “patchy growth in credit cards”.

On the upside, personal loans recorded their third straight quarterly increase year-on-year, after 11 consecutive decreases dating back to the March quarter of 2008. Personal

loans increased 6.9 per cent since June 2010, but were down marginally by 1.1 per cent on the previous quarter.

Mortgage enquiries declined 17.2 per cent over the period of July 2010 through to June 2011. Applications for mortgages posted their sixth consecutive quarterly decrease – down 10.8 per cent in the June 2011 quarter compared to the same time last year.

Even so, the recent June quarter declined at the lowest rate out of the past six quarters.

Luffman said the contrast in the yearly and quarterly performance results suggested “a levelling in mortgage demand”, with year-on-year declines beginning to slow and quarter-on-quarter results showing signs of growth.

8 — Money Management September 15, 2011 www.moneymanagement.com.au

David Whiteley

Australians want to “do better” when it comes to home ownership - Chapman

By Andrew Tsanadis

Consumer credit demand drops 5.1% since March

By Angela Welsh

from super ($1 billion), the ISN stated.

The research also estimates that in the three years from 2008 to 2010, $1.9 billion was paid in commissions to financial planners on employees’ compulsory super contributions, according to the ISN. “On this basis, all existing account balances must be transferred into no-commission MySuper accounts from 1 July 2015,” Whiteley said.

THE ‘great Australian dream’ of home ownership is still alive, with more than half of Australian renters planning to buy or save for their own home in the next five years, according to St. George Bank’s (St. George’s) Australian Home Aspiration report.

More than 1,000 Australians were surveyed as part of the Lonergan Research report, which found that home owners “aspire to do better” when it comes to the property market.

Young Australians stood out in the survey, with 70 per cent of respondents aged between 25 and 34, and 66 per cent of 18 to 24 year olds expecting to have either purchased or be saving for a property in the next five years.

According to the survey, only 1 per cent of respondents aged between 18 and 24 are expecting to be living at home with their parents in five years time.

On average, St. George found that existing home owners wanted to live in a property worth $150,000 more than their current home, an average increase in value of 30 per cent. To realise their value-adding goal, the research

revealed that 72 per cent of home owners plan to renovate their home.

St. George chief executive Rob Chapman said unstable domestic market trends have influenced many Australians to save and invest over the long-term.

“Our research offers a unique insight into a shift in the mindset of Australians, particularly those aged under 35, who report a desire to slow spending and start saving in order to make their home ownership dreams a reality,” Chapman said.

In other results, the survey indicated that 51 per cent of renters with children have a strong desire to own a property in the short term, compared with 31 per cent of renters without children.

On a national level, 38 per cent of New South Wales renters were expecting to own their own home within five years, compared to 34 per cent of those in Queensland.

“Ultimately, Australians clearly have a strong desire to ‘do better’, whether it comes to owning their own home or increasing the value of their home, illustrating the ‘great Australian dream’ is very much alive and well,” said Chapman.

Australian super funds outstrip global peers

By Mike Taylor THE relative buoyancy of the Australian economy, combined with the compulsory nature of the superannuation guarantee and the continuing consolidation of the Australian superannuation industry, saw asset growth outstrip that of other nations last year.

That is the bottom line of new research released by Towers Watson, which found that growth in assets of major Australian institutional funds grew by 26 per cent last year in US dollar terms, compared to a global growth rate of 11 per cent.

Commenting on the survey findings, Towers Watson Australia senior investment consultant Martin Goss said the growth rate for Australian funds in the global 300 ranking over the past five years had been supported by a number of factors, including

ongoing merger activity, positive net cash-flows, and the seeding of the Future Fund in 2006.

He said other factors had been the strong performance of Australian equities relative to global equities, combined with the home country bias of many Australian investors and the appreciation of the Australian dollar relative to the US dollar and the Euro. According to the Tower Watson data, there are 15 Australian funds in the global 300 ranking this year, with all of them climbing the ranks as a result of strong growth in funds under

management – giving them a combined asset size of US$368 billion.

At the top of the tree for Australia is the Future Fund (ranked 35th globally), followed

by AustralianSuper (78th), State Super (93), QSuper (99), UniSuper (105), First State Super (154), ARIA (159), REST (160), Sunsuper (175), Hesta (179), ESSSuper (189), Cbus (191), SuperSA (253), GESB (268), and Telstra Super (274).

Goss said Australian funds were expected to maintain their growth trajectory.

Looking globally, Goss said the world’s largest pension funds had changed their asset mix during the past five years to be more defensive – partly due to ongoing volatility and an unpredictable growth environment – with the top 20 funds (on average) now having equal amounts of equities and bonds, and the rest being in alternatives and cash.

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News

Investor sentiment takes a fall

By Milana Pokrajac INVESTOR sentiment has taken a dramatic fall in the third quarter of 2011, dropping to the lowest level since the first impact of the global financial crisis, according to CoreData.

CoreData has released its

Investor Sentiment Research Report, which found investor confidence was sitting at negative 21.7 – a drop of 15.7 points from the previous quarter.

The survey, which involved 820 participants, also revealed one in four Australians were struggling financially, with 15 per cent

drawing on savings and 11 per cent running into debt to make ends meet.

CoreData’s head of advice, wealth and super, Kristen Turnbull, said investors were shaken by the recent US and European debt crisis and are concerned over the fallout of economic uncertainty.

“80 per cent of respondents predict an economic slowdown over the coming quarter; investors have become much more negative about business conditions, with 68 per cent expecting them to deteriorate – up from 44 per cent last quarter,” Turnbull said.

The report also found that

FOFA borders on social engineering: Duffield

By Chris Kennedy THE Future of Financial Advice (FOFA) and superannuation reforms have been slammed as veering close to social engineering at a Financial Services Council/Deloitte lunch in Melbourne.

Speaking at the conference, Plum Financial Services non-executive director and former deputy chairman of the FSC Jeremy Duffield warned that the Government was stepping beyond the ideal of offering investment choice with boundaries to consumers, and presaging a social engineering approach to industry competition.

“That would come at the expense of free markets,” Duffield said.

Duffield questioned whether the Government considered that FOFA may cause a wave of financial planner consolidation in the industry.

The already existing super fund default options would also become devalued as a result of the Government’s approach to default options, he said.

The Government was trying to take hold of the reins of industry innovation to an unnecessary extent, Duffield said.

“It’s one thing to say consumers can have bounded choice, but another step entirely to say that industry competitors can only compete in a certain way,” he said.

The Government was moving from nudging the industry in a certain direction by tweaking policies, to “shoving them” in the direction it wants to go, Duffield said.

Duffield questioned whether the balance in the “joint venture” of government regulation and industry was shifting too far.

Greg Medcraft

in seeking to have the AAT set aside the cancellation of its licence, with ASIC then appealing that decision in the Federal Court in October.

The Federal Court has now ruled that the AAT erred in its opinion of tangible assets that comply with the NTA requirement of the AFSL held by Opus, ASIC stated.

“The Federal Court’s decision reinforces the integrity of the financial requirements for AFS licensees that operate registered schemes,” ASIC Chairman Greg Medcraft said in a statement.

“Deferred tax assets are not readily realisable or available should a licensee fail.”

Jeremy Duffield

Earlier this year, Opus Capital’s flagship Opus 21 fund was the subject of an attempted takeover by Century Funds Management (now Centuria Property Funds) with Century citing a number of concerns within the fund including a related party loan within the group of $17.3 million, which suffered a 90 per cent write down.

Century failed to gain the 80 per cent of shareholder votes necessary to assume control of the fund.

The matter has been remitted back to the AAT to determine whether Opus’ licence should be cancelled, and the AAT is now required to treat the deferred tax asset as excluded from Opus’ NTA, ASIC stated.

Redundant employees need advice

By Tim Stewart LONG-serving employees who have received a substantial redundancy payout are often in urgent need of financial advice, according to HLB Mann Judd Wealth Management partner Jonathan Philpot.

People who have just received the largest lump sum payment in their life are in danger of making big mistakes without advice from a financial planner – particularly if they are facing the prospect of longterm unemployment, Philpot said.

“For those nearing retirement,

redundancy may provide the opportunity for an additional boost to their savings, enabling retirement to be made sooner and/or more comfortable,” he said.

If the taxable component of the payout is rolled into superannuation, it will only be taxed at 15 per cent, Philpot said. However, he added that for people who were further away from retirement, paying off a large debt (like a mortgage) could be a better idea than taking advantage of the tax savings in superannuation.

“The overriding thing for redun-

dant workers to avoid is going on a spending spree even if they do feel in need of a holiday or retail therapy,” Philpot said.

He also warned against using the

10 — Money Management September 15, 2011 www.moneymanagement.com.au

ASFA differs on ATO income stream ruling

By Mike Taylor

ASIC wins Opus Capital appeal THE Federal Court of Australia has overturned a decision by the Administrative Appeals Tribunal (AAT) which had earlier upheld an appeal from Opus Capital against the cancellation by the Australian Securities and Investments Commission (ASIC) of its Australian Financial Services Licence (AFSL).

Opus Capital is the responsible entity for 14 unlisted property funds, and originally had its AFSL cancelled

by ASIC in August 2010 after the company failed to rectify an ongoing breach of the net tangible assets (NTA) condition of its licence to the Commission’s satisfaction.

In September, Opus was successful

investors without a financial planner were more likely to invest more money into an existing investment (23 per cent) than those with one (17.5 per cent).

All investments – apart from residential property – are expected to perform worse in the next three months, according to the survey.

redundancy payment to make a speculative investment or start a high-risk business, unless the plan had been thoroughly discussed with a financial planner.

THE Association of Superannuation Funds of Australia (ASFA) has taken issue with an Australian Taxation Office (ATO) ruling on superannuation income streams, arguing that they do not necessarily cease on the death of a member.

In a submission lodged with the ATO, ASFA argues that despite the death of a member, a superannuation income stream still exists pending determination of the beneficiaries who are to receive some or all of the superannuation interest, and the form in which it is to be received.

“We do not agree that a superannuation income stream ceases when there is no longer a member who is entitled, or a dependent beneficiary of a member who is automatically entitled to be paid a superannuation income stream from a superannuation interest that supports a superannuation income stream,” it said.

The ASFA submission said, in general terms, once an income stream commenced, it believed the income stream continued to exist under the Superannuation Industry (Supervision) Act regulations until such time as it was commuted to a lump sum or ceased to exist because the amount in the relevant interest had been completely exhausted.

The ASFA submission also warns the ATO be careful in determining the date from which its final ruling should apply, stating that the trustees of superannuation funds would experience considerable practical difficulties in complying with the ruling, particularly if it was retrospective to 1 July 2007.

“The ATO interpretation as outlined in the Draft Ruling differs significantly from that adopted by virtually all trustees of superannuation funds and other pension providers in their administration of pension products,” the submission said.

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SMSF Weekly ATO must review limited recourse borrowing

By Benjamin Levy INDUSTRY experts have called on the Australian Taxation Office (ATO) to review the ban on self-managed super funds (SMSFs) using limited recourse borrowing to fund improvements to property assets.

Speaking at the Small Independent Super Funds Association conference in Melbourne, SMSF specialist executive at Cavendish Superannuation David Busoli said the ban on making improvements to property assets using limited recourse borrowing was a real

problem, with members of the industry either under the impression that improvements were allowed, or making property improvements anyway and hiding it from the ATO. Busoli told the conference of one SMSF he was aware of that had their asset destroyed in the Brisbane floods and rebuilt it without asking the tax office first.

Even though the rebuilding of the asset qualified as an improvement, they didn’t tell the ATO because they knew the application would be refused and they thought they

would have more luck “asking for forgiveness rather than permission”, Busoli said.

One town hall gathering, at which a colleague spoke, was in an uproar because they were told they couldn’t improve their assets but had already done so or were planning to, he said.

Busoli labelled the rule ridiculous.

The National Tax Liaison Group Super Technical Committee has sarcastically questioned the ATO in the past on whether it would allow limited recourse borrowing to fund the rebuilding of a property that burned down.

Cavendish had a running battle to ensure that SMSFs were being compliant on limited recourse borrowing, Busoli said.

A lot of wrong ideas about limited recourse borrowing were floating around, including some involving the banks, and they could create a compliance nightmare, Busoli warned.

Many people were trying to refinance an existing asset using the limited recourse borrowing, which could only be used to acquire new assets, or were using it to acquire properties owned by a related party, he added.

Volatility makes SMSFs not rushing to more cash ATO super income rollovers

By Damon Taylor stream ruling queried time-sensitive SELF-MANAGED Superannuation Fund (SMSF)

By Mike Taylor SUPERANNUATION trustees need to ensure fund members know how long rollovers can take, particularly during volatile markets.

That is the assessment of Institute of Chartered Accountants Australia superannuation specialist Liz Westover who pointed to recent commentary by the chairperson of the Superannuation Complaints Tribunal, Jocelyn Furlan, regarding the number of complaints from people concerned their savings had suffered due to rollover delays.

“While market volatility is part and parcel of investment, recent activity has shown us just how volatile the market can be,” Westover said.

She said market volatility was now an important factor in deciding when and where to undertake rollovers between super funds, but members needed to be aware of the implications of what they are doing.

“Individuals need to appreciate that a reasonable amount of time is required when requesting a rollover, and even in that time, market movement can be significant,” Westover said.

CASH may be a safe-haven for many selfmanaged superannuation fund trustees, but new data suggests the latest bout of market volatility has not generated a new rush.

The Vanguard / Investment Trends Self Managed Super Funds Report found that though overall cash holdings had jumped significantly for SMSF investors in recent years, those cash holdings deemed excess had remained stable at $39 billion.

According to the report, excess cash now represented 35 per cent of SMSFs’ total cash holdings, down from 53 per cent in May 2009.

Commenting on why SMSF cash holdings normally invested in other asset classes during more stable market conditions had dropped so significantly as a proportion of total cash allocations, Robin Bowerman, Head of Corporate Affairs and Market Development for Vanguard Investments, said behavioural finance studies had consistently highlighted that investors were often driven by short term emotional influences.

“They will often buy when markets are high and sell out when they are low,” he said.

“So while a more conservative asset allocation may be absolutely right for an investor’s circumstances, it is vital for investors to remember that a diversified, low cost approach to investing that maintains market exposure during turbulent trading days and looks past the short term volatility has the greatest opportunity of investment success.”

12 — Money Management September 15, 2011 www.moneymanagement.com.au

Robin Bowerman Bowerman said that consciously or otherwise, SMSF investors turning to cash and term deposits were taking a pessimistic outlook on the future growth of the Australian economy and major Australian companies.

“Obviously we have experienced a lot of short term market volatility, and there is uncertainty about where the markets are going next,” he said. “Recent events, however, should reinforce the view that investors are concerned about many things that simply are not within their control, such as geopolitical affairs, markets and economies.

“For Vanguard, the message is clearly about taking a longer term view, having a well-diversified portfolio to suit your risk profile, and keeping costs as low as possible,” Bowerman said.

trustees appear to be equally affected by an Australian Taxation Office (ATO) draft ruling impacting superannuation income streams.

That is one of the conclusions drawn in an Association of Superannuation Funds of Australia submission to the ATO raising key issues with respect to the draft ruling, including arguing that superannuation income streams do not cease where there is no longer a member.

“There is an argument that, on the death of a member, a superannuation income stream still exists, depending on the terms of the trust deed,” the submission said. “It is extremely likely that a final pension payment will need to be made after the date of death, representing the pro-rata pension payment liability which had accrued between the past pension payment and the date of death.

“Once the beneficiary or beneficiaries have been determined, this can result in a total or partial commutation of the pension to pay a lump sum, a total or partial commutation of the pension to commence another income stream, or a total or partial continuation of the same pension,” it said.

The ASFA submission said it was important to note that with Australian Prudential Regulation Authority regulated funds – and sometimes even with some SMSFs – the trustee might not be aware of the death of the pensioner until some time after it had occurred.

It said that, on occasion, this might occur after year-end, and even after the accounts have been finalised and audited and the tax return for the previous year has been submitted.

InFocus INVESTOR SENTIMENT SNAPSHOT

-5.3

4th quarter 2010

-4.3 -6.0

1st quarter 2011

2nd quarter 2011

Predicting collateral damage The Government’s Stronger Super policy package is positioned to deliver on MySuper and the other Cooper Review reforms but, as Mike Taylor reports, there remains considerable scope for unintended consequences.

W

hen the Cooper Review into Australia’s superannuation system nearly 18 months ago generated its MySuper concept, it appeared anathema to a strategy which had been pursued by the financial services industry for most of the previous decade – to encourage member engagement.

As the Assistant Treasurer and Minister for Financial Services, Bill Shorten, last week prepared to release the latest iteration of the policy and legislative package reflecting the Cooper Review’s recommendations – Stronger Super – he would have been doing so fully aware that there are many on his own side of the political fence who believe the MySuper concept is badly flawed.

The critics of MySuper not only believe it is unwarranted in the context of a perfectly functional default superannuation fund regime, but also because it is based on the dangerous assumption that it is acceptable to provide Australian workers with a product which tacitly endorses their continued disengagement from superannuation.

Indeed, the entire concept of MySuper runs counter to the findings of the 1997 Financial System Inquiry which became know as the Wallis Report. Referring to that report, the Government’s own Stronger Super website notes that it argued that “superannuation members could generally be treated as rational and informed investors able to make their own decisions about their superannuation”.

The Cooper Review therefore essentially turned that notion on its head, finding that many consumers do not have the interest, information or expertise required to make informed choices about their superannuation.

It is the disparity in approach between Wallis and Cooper that the Government must therefore have in mind when it delivers the rules

upon which MySuper will be based and, as a starting point, it should not assume that every person who happens to be in a default fund is there because they did not make a choice.

While MySuper has been the headline discussion point in the Stronger Super debate, there has been a far more important associated issue bubbling in the background – that of auto-consolidation.

Auto-consolidation would see people with balances held in multiple funds having those accounts automatically consolidated into a single account.

It is a notion that has attracted the support of the Association of Superannuation Funds of Australia (ASFA) with its chief executive, Pauline Vamos, suggesting earlier this year that it would lead to an aggregate reduction in fees paid by fund members of around $250 million a year.

The problem, of course, is the underlying presumption that people are unaware of their multiple accounts and would therefore welcome consolidation. Evidence exists suggesting some people are very much aware of their multiple account status and happy to stay that way.

The obvious answer for a Government looking to find an appropriate legislative approach is to have superannuation fund members given the opportunity to opt-in, but there are those in the superannuation industry who believe the reverse should be the case.

Enter the chief executive of the Industry Super Network, David Whiteley, a man whose opinions appear to have a pyrotechnic effect on sections of the financial planning industry.

Whiteley early last week utilised yet more research commissioned by his organisation to argue that all account balances within existing default funds on which commissions might be being paid should be transferred to MySuper accounts.

Again, there was the presumption that those people in default funds were there because they had not made a choice and were oblivious to the fact their account balances might be subject to commission payments.

When Whiteley’s contention is put together with the notion of auto-consolidation, then it becomes obvious that the Government must move with great caution to ensure its Stronger Super package does not result in a range of unintended consequences and loud complaints from superannuation fund members that they are being disenfranchised.

There are, of course, those who also argue that the Government will be wrong if it proceeds to implement its Stronger Super package in the absence of allowing the Productivity Commission to address the question of default superannuation funds under modern awards.

While the Stronger Super changes are expected to be a part of the Government’s legislative agenda in the Parliament through the closing months of 2011 and the opening months of next year, the Productivity Commission is unlikely to receive the reference on modern award default funds before next winter.

Given the degree to which modern award arrangements actually compel particular employees towards specified superannuation funds, one of which is MTAA Super, it is a concept that sits uneasily with the broader questions of auto-consolidation and the intended operating and performance requirements of compliant MySuper funds.

Then too, there is the question of how many Australians are really as disengaged as suggested by the Cooper Review.

It is perhaps a measure of the superannuation industry’s broader view on MySuper that many funds are increasing rather than reducing the amount of money they direct towards member engagement.

-21.7 3rd quarter 2011

Source: CoreData

WHAT’S ON

Australian Consumer Finance Forum 22 September 2011 Sofitel Sydney Wentworth www.lendingconference.com.au

Finsia Event – Superannuation Reform What Will Super Look Like In 2015?

4 October 2011 Sofitel Melbourne on Collins www.finsia.com

AFA Australian Microcap Investment Conference Sofitel Melbourne on Collins 18-19 October 2011 www.afa.asn.au/profession_eve nts.php

FSC Deloitte Lunch Future Leaders Award Presentation 28 October 2011 Four Seasons Hotel, Sydney www.fsc.org.au/events.aspx

FPA 2011 National Conference 17 November 2011 Parmelia Hilton, Brisbane www.fpa.asn.au

www.moneymanagement.com.au September 15, 2011 Money Management — 13

Responsible investment

It’s easy being green There has been a growing interest in responsible investments over the past year, particularly among retail clients. Climate change and rising sea levels are just some of the factors financial planners need to be aware of when recommending ethical products to retail clients, writes Janine Mace.

WHEN a client arrives at your office and wants to talk about buying an investment property down the coast for their retirement, what do you think about?

How does it fit into the asset mix in their portfolio? Where are you in the property cycle? How will they fund the purchase?

How about rising sea levels?

While it is not an issue likely to be at the top of the list, it certainly should be on the list if an adviser is doing the job properly.

Many coastal properties in Florida and around the Gulf of Mexico are now considered uninsurable by large insurance companies due to the environmental risks they represent.

According to Responsible Investment Association Australasia (RIAA) executive director, Louise O’Halloran, climate change is an issue advisers cannot afford to ignore.

“The regulatory landscape is leaning heavily towards financial planners taking responsibility for the risk management of their client’s investments,” she explains.

Recent events such as the BP oil spill in the Gulf of Mexico, the Tepco nuclear disaster in Japan, and the phone hacking scandal surrounding News Limited have all highlighted the importance of environmental, social and governance (ESG) risks on the long-term investment performance of corporations.

O’Halloran believes the changing regulatory environment means at the very least advisers need to consider the relevant ESG risks before investing. “These issues should be taken into account, whether the client asks or not.”

Russell Investments director of consulting and advisory services, Greg Liddell, made a similar point in a recent interview with Money Management. “The risks associated with climate change are such that if you make certain investments without educating yourself on those risks, then you are probably negligent in your fiduciary duties and responsibilities.”

He believes the example of the impact rising sea levels could have on Australian coastal property illustrates the point well. “If you are making property investments in

those areas without considering those risks, then that is not a prudent thing to do.”

Liddell went on to note institutional investors have a heightened awareness of the risks around issues such as the insurability of coastal properties when it comes to making long-term investments. “Institutional property managers are very aware of that but I’m uncertain retail investors understand the implications of that.”

Implications for portfolios

It is not just the risk of rising sea levels that advisers cannot choose to ignore, explains Australian Ethical managing director, Phillip Vernon. “If you take the view that the pricing of carbon is going to happen, then you need to consider having a portion of a client’s funds invested to deal with that change.”

This is exactly the rationale outlined in Mercer’s Climate Change Scenarios – Implications for Strategic Asset Allocation report, which recommended large pension funds around the globe consider reorienting their asset allocation to ‘climate sensitive’ assets to help mitigate risk and capture new opportunities.

With the Mercer study finding climate change could contribute as much as 10 per cent to investment portfolio risk over the next 20 years, interest in responsible investment approaches which identify, measure, and incorporate ESG risks into investment decision-making has never been higher.

This is an area investment professionals increasingly see as mainstream, according to Perpetual’s manager, responsible investment and sustainability, Pablo Berrutti.

“These issues are not going away and how companies are considering them will be increasingly important to investors.”

O’Halloran agrees responsible investment and ESG considerations are now far removed from traditional ethical investment funds which focussed on valuesbased investing or screening out gaming or nuclear stocks.

“It is not about screening out a couple of areas that are harmful. We are in the 21st century and massive issues dominate due to things like resource scarcity. They will

14 — Money Management September 15, 2011 www.moneymanagement.com.au

increasingly dominate the investment landscape in the future,” she explains.

“The investment community is learning to look at risks at the incremental stage, rather than when they are catastrophic. We are now trying to put these signs into our financial modelling.

“These are investment and measurement techniques – not a new breed of investment products,” O’Halloran says.

She believes recent events and their impact on the companies involved have demonstrated the importance of ESG risks to the returns investors receive. “It has shown the need to become better at measuring and including risks in the investment management framework.”

Reducing investment risk

O’Halloran believes the investment landscape is changing dramatically as investors search for investments that offer less risk.

“These are not themes in responsible investment but trends in investment management – and they are increasingly being embraced. It is a change in the DNA of the investment world,” she explains.

“Responsible investment is about finding more information and better information about company value in the 21st century.”

This approach to ESG investing is becoming increasingly common in other countries. The European Sustainable Investment Forum’s (Eurosif’s) 2010 High Net Worth (HNW) Individuals and Sustainable Investment Study found sustainable investment was now largely perceived by the European HNW population as a financial discipline (rather than an investment style) and specific knowledge of ESG issues necessary for successful investments.

As William T. Mills III from Highland Good Steward Management (one of the report supporters), noted: “ESG integration is a financial discipline and not a standalone product; the industry must work with the best asset managers to fully integrate ESG policies across a multitude of asset classes, strategies, and products.”

It is a view endorsed by many large Australian institutional investors such as the big industry superannuation funds.

The SuperRatings 2011 Infinity Report found the strongest factor driving the adoption of sustainable behaviour in superannuation funds was the desire to reduce exposure to ESG risk. The study found 53 per cent of fund respondents said responsible investment decisions were incorporated into their decision-making process at the investment committee level, with 61 per cent stating corporate governance was the most important or a major factor when selecting investments.

The growing acceptance of responsible investment practices is being backed by fund inflows. The 10th annual RIAA Benchmark Report found a 10 per cent increase in managed responsible investment portfolios in 2009/10, which saw total Australian portfolios hit $15.41 billion.

According to RIAA, the finding “reaffirms that taking environmental, social and governance issues into account has become best practice for those looking to improve investment performance in the short and long-term”.

The report also highlighted the sector’s continuing good performance. It found the products had outperformed the average mainstream fund over one, three, five and seven years for both Australian and international shares in 2009/10. Balanced growth managed funds outperformed mainstream

Responsible investment

funds over five and seven year periods.

O’Halloran believes performance is no longer an issue. “Responsible investment funds in Australia have outperformed all of their mainstream counterparts.”

Even the global financial crisis (GFC) seems to have done little damage. “The 2010 results include the GFC and responsible investment has done very well compared to mainstream funds,” she notes.

Vernon agrees: “As far as the ethical sector goes, our portfolios tend to be defensive by their nature, so they have tended to perform well during the GFC.”

Berrutti agrees ethical investing holds strong appeal for some investors. “There will always be a place for ethical investments. There will always be people looking to buy their values. Our customers want to invest their values, and will continue to do so for many years.”

O’Halloran agrees: “The market will always want products that take ethical and moral issues into account.”

However, even the traditional ethical investment approach of using negative screens is evolving. “Ethical is becoming increasingly sophisticated and is no longer just about blanket negative screens,” Berrutti notes.

Ethical lives on

Although ESG investing has grabbed most of the attention, ethical investing still remains a key element within the space.

The key difference is ESG methodologies tend to focus on the business case for an investment and creating value – not values.

“ESG integration is about taking a risk based approach to investment,” Berrutti explains.

“For example, the News Limited situation shows the need to consider these risks in the price you pay for a stock, but for ethical funds, the governance issue is so great they will not buy it at any price.”

Ethical funds are not even always about

Louise O’Halloran ‘clean and green’. For example, some Christian funds are based on Biblical values, while Sharia funds exclude products related to usury, blood products and alcohol.

Vernon remains convinced there is a market for ethical investments despite the growing interest in ESG disciplines. “We still see the interest in ethical and believe the interest is actually growing,” he says.

“Ethical investment unashamedly uses a values based investment approach.

Ethical investment offers a distinct point of difference.”

Drive for impact investments

Although interest in responsible investment is growing, several developments are likely to give it further impetus. For example, the standard of company reporting on ESG issues is receiving closer attention.

In August, the Financial Services Council and the Australian Council of Superannuation Investors released the ESG Reporting Guide for Australian Companies, while the International Integrated Reporting Committee is due to release a discussion paper in September on how sustainability measures can be integrated into company reporting.

“Better reporting allows for better decision-making, and so, for the responsible investment community who have long lamented the lack of company reporting, this represents significant process,” Berrutti explains.

“Both initiatives demonstrate a push by mainstream investors and other stakeholders for increased reporting by companies on their non-financial (ESG) performance.”

Shareholder interest and involvement in company activities through AGM resolutions is also growing.

“There is increasing advocacy and putting resolution to companies about their climate performance. Increasing shareholder activism has occurred overseas, and we are seeing an increasing number of shareholder resolutions here,” Berrutti notes.

Vernon agrees this is a growing trend.

“Our Climate Advocacy Fund launched last year builds on the active ownership principle of responsible investment and draws on overseas trends from the UK and the US,” he explains.

“Advocacy with companies is becoming a large trend in the market. It supplements other investment products for retail investors keen to take an active role in engaging with larger companies.”

Developments are also occurring in local governments. Both the Melbourne and Sydney City Councils have introduced legislation making it easier for property owners to upgrade their buildings to meet new energy and environmental standards. The costs are then passed onto tenants through their rates, allowing the expense and benefits to be shared between owners and tenants, Berrutti explains.

At the product level, interest in broadly based thematic funds is rising. “There is a lot more interest in funds based on macroinvestment themes, such as clean technology, food and soft commodities,” Berrutti says.

He believes this interest has been reinforced by the Mercer Climate Change Scenarios study. “It generated a lot of interest in the potential of thematic funds based on themes like resource scarcity.”

Another international development is the emergence of so-called ‘impact investing’. In the UK, the Government plans to unlock the investment needed to deliver a low carbon economy by proposing a Green Investment Bank and the creation of green ISAs (Individual Savings Accounts), which would direct investment to ETFs and other retail vehicles tracking green and low carbon indexes.

“The idea is to de-risk the funding of private investments,” Berrutti explains.

The Australian Government’s proposed $10 billion Clean Energy Finance Corporation (CEFC) is a similar initiative. It claims the CEFC will “drive innovation through commercial investments in clean energy through loans, loan guarantees and equity investments”.

According to O’Halloran, the concept of impact investing is being applied in a number of areas. These include developing micro-enterprises which fund micro-financing and assisting companies working to produce affordable housing or distributed solar power.

“The idea is to create and seek out innovative new investment models that directly stimulate companies that solve big issues,” she explains.

“The question now is how to develop pooled investment vehicles from these ideas.”

MM

www.moneymanagement.com.au September 15, 2011 Money Management — 15

Responsible investment

Hugging assets, not trees The debate around responsible investments has become charged by the controversial and highly discussed carbon tax. However, Janine Mace finds this will not negatively impact the sector.

WHEN it comes to hot topics, they don’t get much more divisive than the debate over the proposed introduction of Australia’s carbon tax.

As Australian Ethical managing director Phillip Vernon notes, “The carbon tax is like religion and money – it is now not to be discussed at dinner parties”.

The rancorous debate has made anything to do with climate change highly political – just at a time when interest in responsible investment is growing strongly.

However, it is not all doom and gloom for those advocating a responsible investment approach. “Regardless of peoples’ opinions on the issue, it has heightened awareness of climate change and helped to make people think about the issue,” Vernon explains.

“People are turned off by the politics of it, but it has made it easier to engage with them about the issue of climate change.”

Despite the bitterness of the carbon tax debate, those working in the responsible investment space believe it will not have a negative impact.

“A few years ago it was hard to engage people about the investment issues, but not now,” Vernon says.

Perpetual’s manager responsible investment and sustainability, Pablo Berrutti,

agrees the controversy is unlikely to affect the broader push towards responsible investment. He believes the debate has made the investment community look more closely at environmental, social, and governance (ESG) risks and their financial impact on Australian companies.

Responsible Investment Association Australasia (RIAA) executive director, Louise O’Halloran, is another who sees the politicisation of the carbon tax debate as having little long-term impact on the shift towards responsible investment.

She believes the consideration of ESG risks in investment decision-making is now so thoroughly embedded in the processes and thinking of large institutional investors and fund managers, it will not be derailed by a mere political bunfight.

“The large investment houses and reinsurers have been investigating the impact of climate change on investment for over 10 years,” O’Halloran says.

“This is an agnostic issue for these people, as they do not want to expose their investors and shareholders to risk. Climate change is an issue for the entire investment community and they will not be swayed by any politicisation, as these processes help minimise risk for investors.”

16 — Money Management September 15, 2011 www.moneymanagement.com.au

planners are “Financial going to get increasing questions from clients, so from a business perspective they need to understand the area and be prepared.

- Mark Tindale

”

HNW investors lead the way

This view of responsible investment as a methodology for minimising investment risk has been embraced in Europe, with the top end of the retail market strongly embracing it.

O’Halloran believes this is a signpost for the future direction of the Australian retail sector. “The action is in the high net worth (HNW) and ultra high net worth (UHNW) sectors; they are the bellwether for trends to come and where the areas of potential opportunity are first identified.”

She cites overseas research which found 20 per cent of HNW and 21 per cent of UHNW investors in Europe and the Middle East are directing money into clean technology investments. “Among HNW investors, 25 per cent are directing over 10 per cent of their investments into responsible investments,” O’Halloran says.

Research by the European Sustainable Investment Forum (Eurosif) highlights the level of retail interest. Its 2010 High Net Worth Individuals and Sustainable Investment Study found this investor group’s responsible investments have increased since the beginning of the financial crisis, even though their overall wealth slightly contracted over the same period.

Eurosif estimates the European HNW

Responsible investment

sustainable investment market was worth approximately $729 billion as at 31 December 2009, and based on current trends, it will account for 15 per cent of European HNW investor portfolios by 2013 (or just below $1.2 trillion).

Interestingly, Eurosif found 94 per cent of wealth managers and 75 per cent of HNW investors thought the financial crisis has had a positive impact on the performance of their sustainable investments. The study found the majority of HNW investors consider financial opportunity to be the main driver for sustainable investment demand.

Just sensible investing

While responsible investment is yet to make similar inroads in the Australian market, the idea of identifying ESG risk as part of the investment process is becoming increasingly popular with retail investors.

RIAA’s 2010 Benchmark Report shows

consumer demand for responsible investment products rose 50 per cent in 2009/10, with ethical advisor portfolios rising to $1.46 billion from $972 million in the previous financial year.

In the wake of the global financial crisis (GFC), retail investors believe the idea of identifying and avoiding risky companies makes perfect sense, according to Ord Minnett senior financial planner, Mark Tindale, who is certified under RIAA’s Responsible Investment Certification Program.

“They are looking for well run, sensible businesses and want to avoid the extremes out there,” he says.

“The demographics of responsible investment clients have not changed that much, as clients want to invest in companies that don’t do dodgy things or are doing sensible things,” Tindale notes.

For Tindale, responsible investment is not about ‘tree hugging’, but rather, hugging your assets. “I feel more confi-

dent doing responsible investment as it is sensible investing.”

He believes many of the risks considered as part of responsible investment help to screen out the problem companies and investments for small investors.

“Responsible investment is about good investing. If you are not comfortable that senior management will take care of shareholders, then you shouldn’t be in that company at all,” Tindale says.

In his view, this is not a fringe approach but is now mainstream investment practice. “A number of the large brokers now have big teams investigating ESG issues before they make share recommendations. Institutional investor demand has led to the quality of research in this area improving enormously.”

According to Berrutti, the responsible investment approach also reduces client nerves due to sharemarket volatility and means funds under management tend to be ‘stickier’. “Investors in these funds are committed to those principles and tend to be less skittish.”

Tindale agrees market volatility tends not to deter those committed to the idea of responsible investment.

“Most good financial planners focus on clients investing for the medium-term of three to seven years. If clients invest in line with that timeframe, then they are willing to ride out the bumps,” he says.

Clients investing in ethical funds tend to be even stickier, as they are investing in line with their values.

According to Vernon, ethical funds are “distinctly different” to mainstream investment funds and this is catching the attention of many advisers. “Some financial planners recognise the difference and increasing numbers are interested in it.”

Going back to school

This interest is translating into a desire to learn more about the area and the differences between ESG and ethical investing, Vernon says. “Financial planners need to understand and get educated on it.”

Tindale believes advisers have varying levels of knowledge when it comes to

responsible investment, and admits it is not for every planner.

“Adviser knowledge is mixed, but it is not for everyone – you should believe in it to do it,” he says. “You need to understand it properly. If you are going to do it, do it well.”

RIAA’s RI Academy offers educational courses ranging from basic through to specialised course for advisers. In November, its new retail market course, RI for Wealth Managers, will be launched.

The course has been adapted from its successful online RI for Financial Advisers course, which has been running since 2006. It will provide RI Academy Certification, and will cover subjects including the rationale for advising clients about responsible investment, creating a responsible investment profile, product selection, ESG analysis for direct shares, and adding value to advice.

Tindale believes RIAA training and certification are important for advisers interested in the area.

Those working in the area believe there are clear advantages for advisers who decide to upskill.

“There are benefits for financial planners, as increasing awareness by clients will result in increasing interest,” Vernon notes.

“Financial planners are going to get increasing questions from clients, so from a business perspective they need to understand the area and be prepared. Clients who are interested are not going to be impressed if you are not able to answer.”

Berrutti agrees this is an area advisers should be equipped to discuss with clients.

“One benefit is you get to know your clients better, and understanding their wants and needs better.”

Stronger client relationships are also combined with real business benefits, he notes. “It is also good for the planner, as this money is much stickier.”

At the very least, advisers should be asking their clients about their interest in the area, O’Halloran argues. “Clients like to be asked if they have an ethical or sustainable preference that needs to be taken into account.”

MM

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3CPAMM02 www.moneymanagement.com.au September 15, 2011 Money Management — 17

OpinionRisk Negotiating the new normal Post global financial crisis regulation, changing government policy and a shift in demographics have created a very different investment landscape to that of previous decades. Matt Hopkins provides guidance on how to deal with the “new normal”.

T

he last 15 years have been characterised by angst over ‘moral hazard’ or the ‘Greenspan Put’.

Investors were implicitly encouraged to take even more risk, because if anything went wrong, the US Federal Reserve (the Fed) would simply step in and cut interest rates. You couldn’t lose.

Moral hazard is rarely mentioned these days. Partly because the US no longer has any scope to cut interest rates – after all, real rates are negative; and also because we have now come to expect intervention as ‘normal’. The Fed remains ready to use new types of stimulus to maintain asset prices if required, and has rebuked the US Government for not being ‘ready enough’.

But today is a different story, with discussion of the ‘new normal’, as coined

by PIMCO, whereby re-regulation, low interest rates, the influence of government policy and shifting demographics create a different investment landscape to that of previous decades.

Some point out that these cycles are all part of the bigger picture. As most would agree, there has always been a major systemic crisis of some sort; it is merely

the details that vary. The question investors are asking is: “what does this mean for our savings and investment strategies?”.

Risk on?

An example came across my desk recently in the form of a research report from one of our research services. The strategists discuss the pros and cons of the current market, but ultimately end up saying ‘we don’t know what will happen, we don’t agree, and we are moving to benchmark’. Moving to benchmark is the investment manager’s equivalent of battening down the hatches and taking no risk. But the benchmark still contains most of the risk for the end investor, who is left to make their own choice as to whether the risks are worth taking.

Australia is somewhat unique in the world, in that our very competitive savings industry has the highest equity concentration of all countries signatory to the Organisation for Economic Cooperation and Development (OECD) convention. This means our funds essentially live and die by the performance of

Graph: Asset performance in high inflation environment

the world’s equity markets, particularly our own. It is worth noting that Australian pensions also had the third largest losses globally (after Ireland and the US).

(Source: OECD Pension Markets in Focus July 2010.)

There is nothing wrong with this per se, especially over appropriate time horizons.

However, it does raise the question of whether that much risk is appropriate at all times – and who makes the decision to alter it? The industry recognises the problem of equity risk concentration, and continues to explore a number of potential solutions.

Addressing risk concentration Risk parity Risk parity seeks to enforce diversification through greater holdings of fixed interest assets. Instead of the bulk of the portfolio holding equities and equity-like risk, the portfolio is constructed such that a greater (equal?) contribution comes from bonds. To get that balance right means a lot of bonds, and to achieve the required return means leverage.

This actually works most of the time, particularly when rates travel steadily downwards, as they have for the last 30 years. It will continue to offer better longterm results if we remain on the path of long-term deflation, à la Japan.

It will not work so well in highly inflationary environments, or when deficit financing becomes a worry for investors.

History shows that when both inflation and real yields rise rapidly, most assets perform very poorly, especially equities and bonds, but also inflation-linked bonds. Commodities may do well if they are part of the inflation problem – otherwise they are also likely to underperform.

The late 1970s provides an example of when all but a few assets failed to transition into an inflationary shock.

Leading historical economists Ken Rogoff and Carmen Reinhart (authors of This Time Is Different: Eight Centuries of Financial Folly) also point out that sovereign debt defaults tend to increase during inflationary periods and banking crises.

Gold and bank share prices suggest this is currently underway. Ultimately, it is sensible to have an active eye on the level

Graph: Buying volatility

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Source: GFDatabase, Bloomberg, AMP Capital

18 — Money Management September 15, 2011 www.moneymanagement.com.au

VXX Price Source: Factset, Barclays iPath S&P 500 VIX short term futures

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and type of bonds one holds under this approach. This must include the option of holding none.

tions here centre on risk and cost. We can hold a long volatility position that will definitely perform well in a sell off, but the cost of holding it in other environments could bankrupt you. The chart below shows the VXX exchange traded fund (ETF), which provides exposure to the VIX index on the S&P 500 (VIX is a direct measure of market uncertainty).

Tail risk hedging Tail risk hedging is where a portion of capital is allocated to option positions intended to pay off handsomely in times of stress. And they do. The crucial ques-

Graph: Realised versus implied volatility 35 30 25 20 15

Dynamic asset allocation Dynamic asset allocation, where asset allocation can be adjusted to reflect changing market conditions, is another option. This is logical, but again requires a framework for assessing the myriad information that comes into play, and allows that information to be reflected in the portfolio. Valuation can be a poor guide at times, but tends to dominate at extremes. An assessment of the earnings and earnings growth outlook – and other factors such as sentiment and market liquidity – is necessary to supplement valuation.

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Yes, the ETF (exchange traded fund) pays off in stressful times, but we would have lost 80 per cent of our capital if we held it for the last two years.

Another way of considering the insurance question is to examine realised volatility versus the market pricing of volatility.

An analogy would be – how many homes actually burn due to bushfire compared to the estimated number of homes at risk implied by insurance premiums.

Unsurprisingly, the implied typically far exceeds the reality. In other words, most people would actually do better selling the insurance. Clearly, timing is important. Critically, a framework of valuation is required to ensure the protection we take is cost-effective, or better still, provides a profit.

Jul 11

S&P 500: 3 month implied Volatility Point S&P 500: 60 Day Volatility Point

Source: Bloomberg, S&P 500 60 day volatility, S&P 500 30 day implied volatility

Graph: AMP Capital Multi Asset Fund (dynamic asset allocation) versus ASX 200 20.0%

The portfolio implications

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At AMP Capital, our philosophy is that providing the best return with the least uncertainty for investors demands all of these aspects. That is – true diversification, tactical tail hedging, dynamic asset allocation and the application of a wellconsidered alternative and active strategies. These are just some of the approaches that can be taken by funds that are actively managed to their objectives, rather than peer groups or strict policy benchmarks. Given this, there are three main themes we are currently applying to our portfolio.

1) Yield Yield is usually the most stable part of an investment return. When capital growth is constrained and market stress is high, yields can become even more attractive.

Australian yields are strong in equities, REITs, and credit. For equities, focusing on higher quality dividend yield has added benefits, as these stocks often demonstrate more capital stability and stronger riskadjusted returns over market cycles.

2) Active management Adding value through active management is a strongly diversifying source of return in a portfolio, whether it be in less benchmark-aware stock selection strategies or hedge funds. However, this also requires different skill sets and perspectives. While many hedge fund strategies have struggled in the high correlation world of macro-driven ‘risk on’ and ‘risk off’, fundamental stock selection and arbitrage strategies do ultimately have periods of opportunity during and after market stress. Australian equities also continue to offer strong and consistent rewards from active management.

3) Patience Stress usually means that valuations reach a point where they become so attractive that the worst is almost certainly discounted. It is always at times of extreme uncertainty, and accompanied by a cry of ‘this crisis is different’. To take advantage of cheap valuations requires a plan, skilled managers, patient investors and cash on hand.

While there are no guarantees in life, the freedom to invest in the most attractive assets and most diversified mix, and to selectively add protection at the right price, makes for a more robust outcome for investors. And this is regardless of whether it is the new normal, abnormal or same old normal.

Matt Hopkins is a senior portfolio manager at AMP Capital.

www.moneymanagement.com.au September 15, 2011 Money Management — 19

OpinionSuperannuation

Super for dummies Lack of investor engagement with superannuation is a widespread issue. Bill Buttler provides guidance on fee comparison for retail investors, and argues standardised measures would help both consumers and financial advisers.

A

major finding from the Government’s Cooper Review into the superannuation system was that it is too complicated, and as a result, people are not engaging with their superannuation.

Superannuation is a complex product.

It packages insurance, investment and retirement funding – each of these can be a difficult technical topic in itself. Thus, it is not unusual that consumers’ eyes glaze over when confronted by the jargon used in modern superannuation literature.

However, even granting the inherent complexity of superannuation, the current regulatory structure does very little to help interested consumers understand and compare superannuation products.

Investors would be better equipped to make decisions about super if the Government mandated standardised measures and terminology for more meaningful comparison of investment strategies and fees charged by superannuation funds.

provides optimum insurance may be the best solution.

• Later in their working life, when superannuation balances are larger, personal commitments are lower and retirement is much closer, employees may be more willing to pay a higher fee for professional advice regarding investment or retirement strategies.

To enable consumers to make informed super fund choices, fees and costs should be separated into three components: • Administration; • Advice; and • Investment.

This may seem obvious, but many funds currently charge a single fee to cover all these components. Some funds charge a separate dollar fee for administration, but part of the “management fee” covers administration and advice, as well as investment management costs.

So what’s the big deal? A young employee wanting to choose a low-cost fund to receive contributions from a part-time employer would have to understand the complexities of such a fund’s investment strategy to be able to assess whether the package as a whole represents reasonable value for money – an unreasonable demand.

Investment strategies – not just performance measures

When investors compare super funds, they should consider: • The expected future return; • The risk of future volatility; • Their personal risk appetite; and • Other risk characteristics such as liquidity and risk of default.

One of the components of the Government’s new “Stronger Super” reform package is the introduction of a standardised “MySuper” fund as the basis for compulsory super contributions for employees who do not wish to choose their own investment strategy. MySuper may go some way towards simplifying the investment component of superannuation, but employees will still need a method to compare MySuper strategies offered by different funds when they change jobs. The only tools currently at their disposal are the published past performance and the trustee’s stated strategy and objectives. The major difficulties with these tools are a lack of standardisation in the calculation methods and the presentation of the results (if you can find them).

To help investors make informed comparisons and decisions about their super fund, the Government should mandate and provide free access to additional measures to facilitate more accurate comparisons of a fund’s investment strategy: • Average performance, net of investment-related taxes, fees and costs, calculated on a consistent basis over one or more (agreed) timeframes; • A measure of historical volatility, such

Comparing fees and costs

as the “standard risk measure” recently introduced by the Association of Superannuation Funds of Australia and the Financial Services Council; • A liquidity measure such as the percentage of “listed” versus “unlisted” assets; • A standardised management expense ratio or an equivalent measure of investment-related fees and costs; • Other standardised indicators of investment strategy differences such as “growth” versus “defensive” assets, overseas versus domestic assets, hedging ratio for overseas assets and use of “active” versus “passive” management.

Many fund members would need professional advice to understand and apply all of these measures, but they would be assisted greatly if advisers and commentators have access to a standardised set of regular performance measures.

Separating fees and costs

A major weakness of the current disclosure regime is a lack of clarity in how fees and costs are charged and disclosed.

While fees are by no means the main

20 — Money Management September 15, 2011 www.moneymanagement.com.au

driver of retirement outcomes, it should be possible for consumers to at least understand and compare the fees charged by different funds.

Some fees simply cover administration services such as the cost of collecting contributions, keeping records, and in some cases, additional services including web access and helplines. For most consumers, there’s little point in paying extra fees for administration, unless they believe the additional services are worth the cost.

By contrast, many investors will be prepared to pay higher investment fees to gain access to asset classes that may earn better investment returns or achieve a better diversification.

The fees consumers are willing to pay should vary according to their life stage. For example: • For younger employees starting their first job or changing employers for the first time, the focus will usually be on portability, simplicity and low fees.

• As employees move into the early stages of family life, when families are young and mortgages are high, a fund that

The Cooper Review suggested that the regulatory body (APRA) should produce a “league table” enabling fund members to compare fees on a consistent basis. The difficulty with this proposal is that the impact of administration fees on a fund member’s account balance depends on the combination of fixed dollar and assetbased fees, and the size of the member’s account balance and annual contributions. As such, every case is different.

Moreover, the fixation on fees is unhealthy, unless it is placed in the context of retirement outcomes (which are, after all, the ultimate objective of retirement funding policy).

A better approach would be to focus on the impact of administration fees and costs on the eventual retirement benefit outcome over a working lifetime. APRA could provide projections for a hypothetical employee starting a career at age 25 and retiring at age 65, ignoring differences in investment strategy, but showing the impact of administration fees and costs alone. An even better approach would be for APRA to provide a standardised framework for super funds to do the calculations themselves.

Bill Buttler is the convenor of the Superannuation Benefit Projections Working Group, Institute of Actuaries of Australia.

ResearchReview Reflecting fair performance fees Research Review is compiled by PortfolioConstruction Forum in association with Money Management, to help practitioners assess the robustness and disclosure of each fund research house compared with one another, and given the transparency they expect of those they rate. This month, PortfolioConstruction Forum asked the research houses: what is an appropriate fee structure and level for an Australian equities fund for which performance fees are charged?

LONSEC

Lonsec believes the adoption of a performance fee addresses the key issue of aligning interests of fund managers and investors. Performance fees change the incentive structure for a fund manager to make it congruent with the interests of investors, by aligning the fund manager’s fee earning potential with the performance outcomes for investors.

Capacity management provides an example of the way performance fees may positively influence fund managers.

We consider a high level of funds under management (FUM) to be counter to the interests of unitholders, because the ability of a fund manager to outperform over time increases in difficulty as FUM increases. A fund manager may potentially be motivated to gather FUM to maximise revenue at the expense of investment performance. The potential to earn performance fees may deter this kind of behaviour by providing them with the opportunity to share in the upside alongside investors.

Consequently, all Australian equity funds could potentially benefit from a performance fee structure. The strategies that may benefit the most are those that more frequently encounter capacity issues – small-cap strategies, some long/short, and concentrated ‘best ideas’ strategies.

While we believe in the general concept of a performance fee, the appropriateness of a performance fee is determined by a number of factors that may vary between funds, including: 1. The performance hurdle – hurdles observed include: • a benchmark (eg, ASX-300); • a benchmark plus the base management fee or other margin;

• the cash rate; • zero.

Lonsec has a preference for benchmark linked hurdles for strategies that are fully invested and hurdles other than zero for more benchmark unaware strategies.

2. A high watermark – we have a strong preference for the use of high watermarks, where managers may not charge performance fees until previous losses are recouped, and we prefer not to see resetting high watermarks.

3. The level of performance fee and the level of base fee – the introduction of a performance fee should be met by a reduction in the base fee. The range of performance fees observed across the Australian equities spectrum has ranged from 10 per cent to 20 per cent. In general, the more capacity constrained the strategy, the more defensible the level of performance fee. The level of performance fee should preferably have an inverse relationship to the base fee.

In practice, the heterogeneity of available strategies and the potential number of moving parts in a performance fee structure means that an ‘apples to apples’ comparison of fees between competing funds can be difficult. The inclusion/omission of any of the above factors also does not automatically mean a performance fee is appropriate or otherwise.

For example, the performance fee on Aviva Investors High Growth Shares Trust is considered by Lonsec to be appropriate, although it does not employ a high watermark and has a performance fee of 20 per cent, which is at the top of the range. However, its performance hurdle of ASX-200 plus 5 per cent is considerably more onerous than other funds.

MERCER

An appropriate fee structure is one that is aligned with the long-term objectives of the investor, truly reflects manager skill, fosters sustainable alpha and is conducive to a long and cost controlled relationship between manager and investor. But no one size fits all. The ideal fee structure will be specific to the investor and the situation, and the engagement of a fund manager should be based on strategy first, fee structure second.

It is ideal to avoid assessing investment managers on the basis of short-term performance as this amplifies the risk of making decisions that are not in the longterm best interest of the investors. That is because of the inconvenient truth that performance data contains high levels of statistical noise – making it very difficult to distinguish between luck and skill. The shorter the period in review, the less useful the information we can deduce. Skilled managers can struggle with their performance for material periods primarily on account of ‘bad luck’, and the reverse applies for unskilled managers who experience a run of better fortune.

This situation has direct application to the method of remunerating fund managers – in particular, via (traditional) performance fee models. Fund managers generally seek, and rightly so, to be judged over a full market cycle as that is the period over which skill can materialise.

However, fee structures often stipulate the payment of a performance fee over a much shorter period, with one year being the most common. It is fair to ask – is this logical and is it compatible with aligning investor interests? The flow-on effect of using relatively short time periods for assessing and rewarding manager performance is that it encourages portfolio managers and analysts (and in turn,

corporate executives) to focus on similar timeframes when evaluating market opportunities. This is likely to be detrimental to maximising long-term returns.

Within this picture is the reality that if an investment manager is replaced, costs are incurred. The more obvious costs are the transition costs, including product entry/exit spreads or brokerage and adviser fees to assist in the selection of replacement candidates. Less obvious costs are time deliberating on the issue, negotiation of new contracts including legal fees, the rewriting of fund documents, and communicating with stakeholders about the change.

There may also be tax implications and market risks to manage as part of transitioning the portfolio. Such costs, ideally, are best avoided – unless the change has a strategic imperative.

So in summary, performance fee models should reflect payment based on: • outcomes reflecting skill, not luck; • encouraging alignment with the investors’ long-term objectives; • rewarding business practices that foster sustainable alpha; and • promoting an enduring partnership and controlling total costs.

Focusing on these factors offers several benefits, including signalling that the investor is serious about focusing on longer term goals, which encourages the manager to develop and maintain a longterm mindset. This approach also fosters a partnership that can benefit both parties, and avoid manager switching costs. It places the emphasis less on rewarding noise/luck (shorter periods) and more on skill (longer periods) and achievement of the primary goal. Finally, it can promote moderate manager trading activity/portfolio turnover, and hence, lower transaction costs.

www.moneymanagement.com.au September 15, 2011 Money Management — 21

ResearchReview STANDARD & POOR’S

Standard & Poor’s believes an appropriate performance fee structure can help to align the interests of investors and fund managers by reducing the manager’s incentive to gather assets at the possible expense of alpha. This can be particularly relevant in the small-cap sector, where capping funds under management can help ensure a manager retains appropriate flexibility to continue to meet its performance objectives.

Where a manager is charging a performance fee, we prefer to see it is doing so on the basis of a reduced management fee. The manager should be prepared to back its ability to deliver superior returns.

Other features to consider when assessing a performance fee are the hurdle rate above the benchmark, the presence of a high watermark (including any built-in reset clause), and the calculation and frequency of payment.

• Hurdle rate above benchmark – most managers require a fund to outperform the benchmark after fees before a performance fee is charged. However, we would like to see a greater trend towards performance fee hurdles reflecting outperformance objectives above an appropriate benchmark. It is also critical to understand the risks a manager has assumed to generate the excess return upon which a performance fee may be payable. For example, is outperformance simply due to leverage of benchmark returns in the case of a hedge fund manager?

• A high watermark – this ensures a manager cannot accrue performance fees until a fund’s unit price is above its previous highest level or p re v i o u s u n d e r p e r f o r m a n c e h a s b e e n re c o u p e d . T h i s i s a v i t a l c o m p o n e n t o f performance fees and should be mandatory.

High watermarks should not have a built-in reset clause. If a manager fails to meet its performance objectives, it should not be given a second chance until investors have recouped their losses.

• Pa y m e n t – h ow f re q u e n t l y d o e s t h e performance fee accrue and when is it payable? Performance fees should be paid at a suitable frequency. Short-term payments may encourage managers to focus on shortterm gains, which may not be in the interests of investors. An important consideration for open-ended funds is how the performance fee is calculated. The fund-level approach, where all fees are calculated at the overall fund level, can cause inequities between investors with different application/redemption timings. In the hedge fund space, performance fees are often calculated through either the equalisation or series method. These approaches are designed to ensure incentive fees, to the extent possible, are fairly allocated between each investor.

In the domestic small-cap space, we regard the performance fee applying to the Ironbark Karara Small Companies Fund to be one of the better incentive fee structures in place. It i n c l u d e s a m e a n i n g f u l h u rd l e a b ov e t h e S&P/ASX Small Ordinaries Accumulation Index, and is only charged when fund returns are above zero.

S&P is particularly wary of performance fees a p p l y i n g t o b ro a d e r- b a s e d , l a rg e - c a p Australian equity strategies in the absence of a significantly reduced management fee or a meaningful limit on stated capacity.

MORNINGSTAR

In a perfect world, we would like to see fulcrum fees adopted in Australia. A fulcrum fee is a perfectly s y m m e t r i c a l f e e s t r u c t u re w h i c h re w a rd s f u n d managers on the upside, but equally penalises them on the downside by reducing the size of the base fee.

This relatively simple fee structure is fair to both fund managers and investors, and does away with many of the complicated facets of existing performance fee structures. Unfortunately, current methods of charging fees are generally considerably more profitable for the fund manager – so don’t expect to see the adoption of fulcrum fees unless the regulator gets involved.

In the meantime, Morningstar believes there are a number of key areas to consider when selecting a fund with a performance fee.

1. Make sure a fund’s performance fee is benchmarked to an appropriate index. This is especially important in rising markets: funds with absolute fee structures can take advantage of a rising tide and charge fees for relative underperformance.

2. Ensure the fee structure has a high watermark that cannot be reset. This stops investors being charged a fee when a fund manager is merely making up previous underperformance.

3. A decent hurdle is a must. The amount of outperformance the manager needs to post before it begins taking fees is significant. The bigger the hurdle, the better – but it should at least cover the base fee. If it doesn’t, the fund

22 — Money Management September 15, 2011 www.moneymanagement.com.au

manager can take a fee even if it underperforms.

4. Take note of the actual performance fee quantum, as all else being equal, the higher the fee, the more you pay. However, you may be better off paying a higher performance fee to ensure the overall structure has an equities-relative benchmark, a high watermark, and a satisfactory hurdle, as the omission of any of these can prove even more costly.

5. Favour longer crystallisation periods. This is the frequency at which the fund manager can charge the performance fee. Managers with quarterly crystallisation periods may, for example, be tempted to focus on shorter term performance chasing.

In Australia, it is rare to find a manager who ticks all of the boxes. We believe Maple Brown Abbott has a very good performance fee structure. Those with notable drawbacks include: • PM Capital, which uses an absolute benchmark; • Aviva, which tends to run without high watermarks (but does have very large hurdles); and • Alphinity, whose decision to reset its high watermark was a big negative.

Nevertheless, in the vast majority of cases, the base fee that a manager charges will by far be the most significant cost to the investor. It has to be paid, rain or shine – so if looking for value for money, look for a manager which has a low base fee, and therefore a real incentive to outperform. In our view, all funds with performance fees should also have lower base fees, but this is seldom the case.

ZENITH INVESTMENT PARTNERS

VAN EYK

Of fundamental importance is the degree to which van Eyk thinks the theoretical alignment of interest provided by performance fees actually brings about a different or improved outcome for investors. Will the presence of a performance fee change a manager’s behaviour? On the one hand, it seems unlikely that adding, for instance, a share class with a performance fee component to an existing product will materially influence an existing team’s ability to outwit the market. At the other end of the scale, it seems equally intuitive that hedge funds may succeed in attracting a specific type of individual willing to back their own judgement due to both the quantum and type of fees inherent to the business model. It is equally plausible that those in charge of such a firm are likely to be highly motivated to ensure the conditions are in place where excess returns are likely to be generated (be they above cash or another benchmark). In that sense, outperformance has become mission-critical, and the performance fee is a critical part of the structure – even if that can also lead to an element of optionality and excessive risk taking under certain scenarios.

That said, all other things being equal, van Eyk’s view is that properly designed, performance based fees can strengthen the alignment of interests between the investment managers and fund investors. ‘All other things being equal’ specifically means ‘as long as investors don’t end up paying more overall and on average’. On that basis, we believe that to be effective, performance fee structures should at least include: • A perpetually high watermark – this means any underperformance must be fully recovered before incremental

performance based fees can be charged. This provides a more equitable structure for the fund manager and fund investors to share both the upside and downside of performance risks.

• A performance hurdle – the appropriate benchmark for performance based fee measurement should include a performance hurdle that is commensurate with the investment risk of the strategy.

• A competitive asset-based fee – the level of asset-based fee should encourage the fund manager to carefully manage fund capacity (reducing the temptation to build assets under management just to obtain higher fees).

The evidence as to whether performance fees lead to better performance is mixed. The top two performing funds in van Eyk’s most recent concentrated Australian equity fund review did not take performance fees (Hyperion and Dalton Nicol Reid). However, a very large proportion of the other funds that did charge performance fees also outperformed over the past three years (in a universe where consistent alpha is rare). In some instances, we have marked down a good team and process due to the weight of fees having a significant impact on likely levels of outperformance after fees (K2 is a well publicised example in the local universe). However, the IFP Global Franchise Fund was rated ‘AA’ despite quite high fees, which it has more than justified.

For that reason, we believe that in assessing the effectiveness of performance fees, the context for the individual firm is as important as the principle of alignment, and that broad brush assumptions about the effectiveness of performance fees might merely lead to higher fees with little or no noticeable impact on performance.

In principle, Zenith is comfortable with the philosophy of a manager being rewarded for strong performance via a performance fee, where the performance fee structure aligns the interests of the manager with that of the fund’s investors. In particular, we are comforta b l e w i t h a n a p p ro p r i a t e l y s t r u c t u re d performance fee for funds with FUM capacity constraints, as this provides potential revenue upside for the manager when closing the fund in the interests of protecting returns for existing investors. In general, capacity constrained asset classes tend to be the domestic asset classes including: • Australian equities – large capitalisation funds • Australian equities – small-capitalisation funds • Australian equities – long/short funds • A-REIT funds • Australian hybrid funds • Australian bond funds The most capacity constrained domestic asset classes/capabilities are Australian equities smallcap, Australian equities long/short, A-REIT funds, and Australian hybrid funds. With the exception of the latter, and to a lesser extent, A-REIT funds, performance fees are common.

In principal, Zenith believes the investment management fee should be around 20 per cent lower for a fund that also has a performance fee structure. This shows goodwill on the part of the manager in reducing the base fee charged, and further incentivises the manager to exceed its performance fee benchmark. The actual base fee level will vary from asset class to asset class, but as an example, Zenith likes to see Australian equities small-cap managers who have a performance fee with a base fee of around 0.90 per cent per annum to 1.00 per cent per annum.

Zenith believes best practice for performance fees is as follows: • 15 per cent of outperformance above the benchmark; • The benchmark to be the relevant market index for the asset class for which the fund invests in plus 1.0 per cent; • The existence of a high watermark such that a performance fee is not payable unless the fund has outperformed its benchmark AND the unit price is higher than when the last performance fee was paid. This guards against paying a performance fee when the fund may have outperformed its benchmark, but absolute returns are negative; and • Payment frequency to be annual at the end of June each year.

It is important to understand that performance fees will not be equitable for all unitholders in a fund. The return each unitholder experiences will vary depending on when they entered the fund. As an example, a unit holder may invest in a fund just prior to 30 June, when a performance fee will be paid if the fund satisfies all of the qualifying criteria. That investor will not have enjoyed all of the outperformance, having just invested in the fund, but will still pay the performance fee. The only way around this, is that the performance for each unitholder is assessed – and this is very intensive for the unit registry to administer, and as such, is not common. That is why Zenith believes an annual performance fee payable as at 30 June is best practice, so investors can elect to delay investing into a fund until after 30 June.

In association with

www.moneymanagement.com.au September 15, 2011 Money Management — 23

ResearchReview The economic costs of short-termism Short-termism is a pandemic that continues to flourish unchecked within financial markets, resulting in significant long-term economic costs to investors. Mark Arnold and Jason Orthman examine the economic costs of excessive short-termism by active fund managers.

M

ost active equity fund managers that survive over the long-term have investment philosophies focused on exploiting mispricing events, where stock price and long-term intrinsic value have moved apart. It is the process of price moving towards intrinsic value that provides active managers with alpha. For reasonable quality businesses, intrinsic value should be fairly stable over the short to medium term, and actually trend higher over the very longterm. Therefore, selling of stocks should normally occur when the price/value gap has closed or another more attractive opportunity is available. The timing of the alpha production is therefore uncertain over short periods of time.

Despite this, most active fund managers are pushed towards short-term thinking.

The majority of funds are in the form of open-ended mandates where investors are able to withdraw some or all of their funds at any time. Because short-term relative performance can vary significantly above or below the benchmark, and investors are able to withdraw funds at any time, many fund managers undertake activities to reduce short-term relative underperformance risk.

Portfolio managers argue that “failure to achieve acceptable benchmark performance in the short run could lead to large fund withdrawals and their possible dismissal” (Rappaport, 2005).

However, periods of short-term underperformance relative to peers or the benchmark are to be expected, even for portfolios that perform well over the long-term. Funds that produce alpha over a 10-year period can be expected to underperform significantly in quarterly, yearly and even rolling three-year periods (Brandes Institute, 2005).

Increased levels of fund specialisation have also tended to result in more frequent fund performance reviews by asset consultants and trustees, and an automatic increase in the focus on short-term performance. In theory, it takes between 25 to 40 years for a

manager’s track record to reach statistical significance (Donoho et. al., 2010; Philips, 2003). While this is too long in practice, it highlights the need to focus on longer rolling performance records.

Unfortunately, behavioural biases often result in managers being hired after a short period of strong performance and eliminated after a short period of underperformance. Krehmeyer (2006) cites a number of studies where asset managers are fired just before performance improves and hired immediately before performance declines. A more recent 2008 study by Goyal and Wahal which examined the selection and termination of investment management firms by 3,400 plan sponsors between 1994 and 2003 found that plan sponsors hired investment managers after superior performance but on average, post-hiring excess returns were zero. Postfiring excess returns were frequently positive and sometimes statistically significant.

One way active fund managers attempt to reduce short-term underperformance risk is by being more active – that is, by undertaking more short-term trading activities. In 1955, the average US fund held its portfolio for seven years; 50 years later, the average stock was held by the average fund for just 11 months (Bogle, 2005). The average holding period for Australian equities has declined from more than six years in 1986 to under one year currently. An increase in market velocity should correspond to an increase in competitive intensity over shorter time horizons. Thus, the probability of outperforming is higher by basing investment actions on longer time horizons (five to ten years rather than six to 12 months). Miller (2006) refers to this as time arbitrage and Gray (2006) explains how this can persist, as very few managers are willing to accept the high level of career and business risk required.

The reality is that short-term stock returns are extremely difficult to forecast accurately because of inherent market volatility.

24 — Money Management September 15, 2011 www.moneymanagement.com.au

Gerlach (2005) found that market volatility cannot be fully explained by fundamental factors. Schiller (1981) found that market returns are more volatile (uncertain) when measured over short periods of time than when measured over more extended windows.

Looking at Australian equity index returns over rolling 12-month periods from 1969 to 2011 shows that although the average 12-month change in the market PE was close to zero, the spread of return contributions due to changes in historical PE ratios was very wide, and significantly wider than the spread of return contributions for short-term EPS growth (note, the average contribution to shortterm returns from earnings growth was also close to zero). Over longer periods, the absolute range of the PE ratio change stayed fairly similar to its contribution to returns over the short-term. However, the long-term return contribution from EPS growth showed a significant increase in the contribution to positive market returns. Both the upper limit of the EPS return range and mean moved significantly higher while the downside contribution was similar to that seen in the 12-month return analysis. The ability of EPS growth to positively bias long-term stock returns is a key reason why the risk of investing is reduced by taking a longer term approach.

At an aggregate stock market level, buying when PE ratios are high (low) relative to sustainable or normalised earnings will normally result in poor (good) subsequent long-term returns to the investor.

However, over short-term periods of time, the market’s PE ratio is not an accurate predictor of future returns – nor is earnings growth a good predictor of short-term market returns.

These two fundamental factors – PE ratio change and earnings growth – have strong explanatory power for long-term market returns. Long-term earnings growth has a consistently positive influence on future

market returns at different initial PE ratio levels, whereas PE ratio change has a positive influence at low initial PE ratio levels and a negative influence at high initial PE ratio levels. At low initial PE ratio levels, both earnings growth and PE ratio change have a positive influence on future long-term returns. At high initial PE ratio levels, earnings growth continues to have a positive influence on future long-term returns, but PE ratio change has a large negative influence on future returns.

A key benefit of taking a long-term fundamental valuation approach to investing is that short-term volatility of stock pricing can provide additional incremental returns. By increasing (decreasing) exposure to equities during cyclical downturns (booms) when PE ratios are low (high), patient investors can receive excess returns.

What can be done?

To address short-termism at the fund manager level, we suggest investors: • Commit funds for a defined period – which would be ideal, although unlikely to be practical; • Extend performance measurement to five years (or more). Monthly, quarterly and yearly performance figures are not a sensible basis on which to make decisions on whether an active fund manager has performed well; • Pay annual bonuses on the basis of rolling medium to long-term performance; and • Require portfolio managers to make meaningful investments in their own funds.

Note: This is an abridged extract from the paper that won the Editor’s Pick Award for best Due Diligence Forum Research Paper at the 2011 PortfolioConstruction Forum Conference. The full paper is available at www.PortfolioConstruction.com.au.

Mark Arnold is chief investment officer and Jason Orthman is a portfolio manager/analyst at Hyperion Asset Management.

Research Round-up PortfolioConstruction Forum presents the most recent projects conducted by major funds research houses over the past month.

LONSEC

Released in August

• Lonsec – Month in Review • Lonsec – Chart Pack update • Lonsec – Quarterly Income Investment Journal • Lonsec – Global emerging markets sector review • Lonsec – Alternatives (hedge funds) sector review • Lonsec – Au Equities concentrated sector review • Lonsec – Perspective: Market update • Lonsec – Perspective: Active vs Passive, the debate continues • Lonsec – Perspective: Fast economies, supersized equity returns?

• Mercer – Monthly Market Review • Mercer – Market Volatility Update • Morningstar – Alternatives funds sector wrap • Morningstar – Talking point: market selloff • Morningstar – Monthly Economic Update • Morningstar – ETF Monthly newsletter • Morningstar – Monthly Index Survey • Morningstar – Monthly Asset Class Performance survey • S&P – Monthly Economic & Market Report • S&P – Infrastructure fund sector report • S&P – Global REITs sector report • van Eyk – Au Equities income funds sector review • van Eyk – Au Equities mid cycle sector review • van Eyk – Global Economic Update • van Eyk – Investment Outlook Report • van Eyk – Discussion: Stage set for property trust recovery • van Eyk – Discussion: Two ways to find value in volatile markets • van Eyk – Special Bulletin: Response to market turmoil • Zenith – Monthly Economic Report • Zenith – Global long/short sector review

Upcoming in September

• Lonsec – Au Equities large cap sector review • Lonsec – Global Property Securities sector review • Lonsec – Residential Property Sector Overview • Morningstar – Multisector funds sector review • Morningstar – Fixed income sector review • Morningstar – Large cap Int’l share fund sector wrap • S&P – Australian equities large cap sector review • S&P – Alternative strategies equity sector review • S&P – Multisector funds sector report

In association with

• Lonsec has been awarded the Money Management Fund Ratings House of the Year Award for the second year running. Presented at the 2011 PortfolioConstruction Forum Conference, the awards survey the views of financial planning dealer groups and fund managers. Lonsec topped the ratings in both constituencies.

• The rise of the core/satellite approach to building portfolios, and the rise of SMAs, is driving an increase in the number of Australian equity concentrated funds, according to Lonsec in its latest review of the sector.

Most concentrated managers are running strategies that employ a similar style, philosophy, and process to their traditional core offering – with the key difference being in the portfolio construction process, Lonsec found.

“Typically, this difference is the manager constructing a ‘best ideas’ portfolio,” Lonsec explained. However, the majority of managers in the sector struggled to significantly grow funds under management (FUM) over the past year. Lonsec awarded a Highly Recommended rating to two funds – the Hyperion Australian Growth Companies Fund and Tyndall Australian Share Wholesale Portfolio.

• Specialist emerging market managers with dedicated resources and tailored investment approaches should be preferred for emerging markets, according to Lonsec. Despite the growing global awareness of emerging markets as a source of potential return, the sector remains a more inefficient research pool than developed markets, particularly for those managers comfortable investing in the less heavily researched mid cap stocks. “This gives fundamental, active managers with well formulated investment research processes a greater opportunity to exploit insights gained from direct company contact and the research effort in general,” Lonsec argues, adding it prefers an active investment approach when allocating to emerging markets.

STANDARD & POOR’S FUND SERVICES

• Standard & Poor’s is launching its international equities research capability into the Australian market in September. The research incorporates both qualitative and quantitative research on selected global equities, including S&P analysis on valuation, risk, and cross-asset analytics.

• S&P Fund Services has announced the finalists in the 2011 S&P Fund Awards. The awards, including 10 sectors plus the overall Product Distributor of the Year and Fund Manager of the Year, are based on a qualitative assessment of specific investment-management capabilities within a sector, rather than being based on past performance of individual funds.

VAN EYK

• Fund managers with an urge to merge need to tread carefully, according to van Eyk in a

recent discussion piece. “Like the merger of any two corporate entities, bringing together two or more investment teams and structures poses challenges and fund managers don’t always get it right,” van Eyk notes. The type of consolidation that can enhance a manager’s ability to outperform the benchmark includes a merger of two boutique firms, which can result in increased resources, better access to sell side analysts and company management, and reduce the time each investment professional spends on non-investment tasks. Less favourable consolidation activity is driven by economies of scale, or distribution or cost synergies, van Eyk writes. “Relatively large investment teams with sizable funds under management may be merged. These types of consolidations are often, but not always, detrimental to the ability of the combined investment team to outperform its benchmark,” van Eyk warns, citing a larger pool of assets reducing the ability to be nimble, demotivation amongst the investment professionals, and changed stock and sector responsibilities reducing stock picking ability.

• The fundamental drivers remain in place for the gold price to go higher, according to Heuristic Investment Systems director Damien Hennessy. A consultant to van Eyk Research, Hennessy believes the factors that have driven the price of gold so far are still in place – namely, low interest rates in most of the world, the threat of an inflation breakout and fears of further currency depreciation. A possible but unlikely threat to the gold price could come from a severe global recession which might see investors revert to old habits and pour money back into the US dollar because of its traditional safe haven status and the lack of an alternative if all economies take a dive, Hennessy warns, adding that a more likely scenario that would threaten gold would be if the US economy improved to the extent that the level of interest rates normalised, but that was still unlikely – at least in the short to medium term, he said.

ZENITH INVESTMENT PARTNERS

• Zenith Investment Partners has been added to the research panel of Melbourne-based financial advisory group, RetireCare Personal Wealth Management, and has been appointed primary research provider for People’s Choice Credit Union.

• Now more than ever, is the time to consider increasing allocations to global long/short funds, according to Zenith, following its latest review of the sector. “The last twenty years have been extremely favourable for global equity markets, with many investors getting an equity beta free ride,” the house writes. Going forward, however, a significant derating of the equity markets and a rising interest rate environment will erode market beta, Zenith warns.

“Investors need a fund that can continue to add alpha by buying high conviction stocks and selling short those stocks likely to fall.”

www.moneymanagement.com.au September 15, 2011 Money Management — 25

Toolbox Structuring insurance inside SMSFs Recommending insurance in a self-managed super fund can be a complicated process.

Troy Smith explores the factors involved in placing insurance in a SMSF and answers some of the questions associated with this process.

R

ecommending insurance in a self-managed super fund (SMSF) can be daunting for those who are dipping their toes in and recommending it for the first time. For those who are a little more experienced – what strategies are available?

Understanding the basics is a great place to begin, so let’s review a few key points.

Policy ownership

Placing insurance in a SMSF involves the super fund owning the policy, where the trustees of the super fund are recorded as the policy owners. As an example, the owner of the policy could be Klaus, and Heidi Pfeiffer as trustee for the Sitges Super Fund.

Notate minutes of the decision to take out insurance

Trustees of a SMSF should minute the decision to take out insurance on the life of a member and the purpose of the policy. It is often assumed that insurance can be paid directly to a member’s account. However, if the fund rules allow, a SMSF may permit insurance proceeds to be paid either to a member’s account, added to the accounting income of the fund or credited to the reserves of the fund. Whatever the decision, the outcome should be suitably recorded.

Insurance payment

The proceeds of an insurance claim are usually required to be paid to the super fund as owners of the policy. At no stage, is it advisable to pay the proceeds of the insurance policy directly to the life insured or other members of the super fund. This is consistent with one of the most basic rules of a SMSF that all

benefits paid must satisfy a condition of release and be consistent with the provisions of the fund’s trust deed. In cases such as payouts due to disability or trauma, a condition of release may not be satisfied.

Paying a benefit

Once a super fund has received the proceeds of an insurance payout, the trustees must decide how it is to be dealt with under the provisions of the fund’s governing rules and whether a condition of release has been met. If a condition of release is not able to be met, the proceeds of the insurance policy must remain in the super fund. If a condition of release is met, the trust deed will indicate how the benefit can be paid as a lump sum, income stream, or a combination of the two.

There are a number of frequently asked questions about SMSFs and investing in insurance policies. Here are some of them: Is a nominated beneficiary required to be recorded on the insurance policy?

No. As the proceeds are paid to the super fund, the trustees of the super fund are responsible for paying a benefit to either a member or a beneficiary.

In the case of a life insurance policy that paid out upon death of the life insured, the proceeds are paid to the super fund, and the trustees may pay a death benefit (death is a condition of release). The trustees may pay a death benefit as required under any death benefit nomination of the deceased, and subject to the rules of the fund.

Can a policy be transferred into a SMSF? SMSFs are generally prohibited from acquiring an asset from a related party.

26 — Money Management September 15, 2011 www.moneymanagement.com.au

Therefore, it is not possible to acquire an insurance policy from a fund member or relative of a fund member. A practice adopted by many insurers is that an existing policy is cancelled and a new policy issued with the SMSF as the owner. Advisers should consider whether the new policy has different terms and conditions compared to the old policy, and consider if underwriting is required.

Case study 2: Jacky (63) also has an insurance policy which includes trauma cover inside her SMSF. Jacky is diagnosed with multiple sclerosis, which triggers a $60,000 trauma payment to her SMSF. She decides to retire and ceases an employment arrangement, which means she meets the retirement condition of release. Jacky is able to access her super.

Can a SMSF own trauma insurance over a member?

Trustees of a SMSF can hold trauma cover within the fund. This position was clarified by the ATO in SMSFD 2010/1.

However, there are some traps for new players: • A super fund can not claim a tax deduction for trauma insurance premiums.

• The occurrence of a trauma event to the life insured usually does not result in a condition of release being met.

If a condition of release is not met, a super fund member must generally wait until preservation age before accessing the benefit (such as the retirement).

While this may have a number of difficulties if the member requires the benefit to pay bills, it can remain in the fund until a further condition of release has been met.

Deciding whether or not to claim a tax deduction

Case study 1: Joan (52) has an insurance policy which includes trauma cover inside her SMSF. She has a stroke, which triggers a $50,000 trauma payment to her SMSF. Joan is temporarily unable to work, but will return to work after a recovery period of eight weeks. Unfortunately, Joan doesn’t meet a condition of release, and is unable to access her super until a subsequent condition of release is met.

One strategy which can be overlooked, is to consider whether the super fund should elect or reject claiming a tax deduction for the death and disability component of an insurance premium.

Generally, super funds can choose to claim a tax deduction for insurance premiums. Where the trustees of the fund decide not to claim a deduction for the premiums, a deduction may be available to the fund for the future liability to pay death and disability benefits. This is available from the time the member’s death or disability benefit has been paid. It may provide a greater tax benefit to the fund than claiming a tax deduction for death and disability premiums on a year by year basis.

Summary

Structuring insurance inside a SMSF provides an opportunity to take advantage of the flexibility offered by SMSFs. Understanding the basics is necessary in order to provide a solid foundation to build strategy. Advisers who understand the strategy have the potential to strengthen their relationship with their SMSF clients and provide some tangible benefits.

Troy Smith is the technical services manager at OnePath.

Appointments

Please send your appointments to: angela.welsh@reedbusiness.com.au

NEWLY appointed regional manager Richard Liverpool will take on a dual regional and national role at Australian Financial Services Group (AFS).

Liverpool will fill the position left vacant by Meaghan Unsworth, who was appointed head of strategic development at the end of August.

Before his appointment at AFS, Liverpool was a senior consultant with the Financial Recruitment Group.

Based in Sydney, Liverpool will be responsible for AFS’ business and recruiting growth in New South Wales and the ACT.

BENDIGOWealth has announced the appointment of three new senior members of its distribution team. Diego Del Rosso, Joshua Parisotto and Christine Koh have recently joined the group, completing the realignment of the distribution department.

Del Rosso joins the firm as the new senior manager, strategic partners and alliances. He brings more than 17 years of relevant financial services experience, covering finance, insurance, funds management and superannuation. Del Rosso previously worked for OnePath, where he was the national sales manager – employer superannuation.

Parisotto joins Bendigo Wealth

planners; monitoring advice quality; promoting the Patron brand in Victoria; and the professional development of Patron’s Victorian advisers.

Patron currently has around 50 adviser businesses in New South Wales and the ACT. It began business in 2007 and has a stated aim of establishing an eastern seaboard presence, and will look to add a Queensland-based role early next year.

Move of the week LISTED financial services firm Plan B Group Holdings has appointed Andrew Black as chief executive officer. Black brings 30 years experience in the financial services industry, and was most recently head of Skandia Australia Ltd when it was part of the global asset management, banking and insurance firm, Old Mutual Group.

The new hire comes almost 18 months after Plan B announced it had made the position of former chief executive, Denys Pearce, redundant.

Black will join Plan B at what the firm has called a critical juncture for the financial planning sector, with the Federal Government recently releasing a draft of its Future of Financial Advice (FOFA) legislation.

Commenting on the appointment, Plan B chairman Bryan Taylor said, “The Board is confident that we have selected a CEO who truly understands the Plan B fiduciary heritage and client-centric approach.”

Black will officially commence the role on 19 September, and will report to the Plan B Board of Directors.

as senior manager, business partner services. He has more than 12 years financial services experience, having worked for independent financial advisers, national licensees, dealer to dealer services and private practice. Parisotto previously worked at IOOF where he was national adviser service manager for independent financial advisers and licensees.

Christine Koh is an internal hire for Bendigo, and has moved to the role of senior manager for business and as partner – delivery team. Koh has worked in a number of customer focused

roles during her last seven years with the bank. She was previously head of Bendigo’s Sydney client service team.

AUSTRALIAN Unity Investment Company Ltd (AUI) has appointed Giselle Roux as a director of the company.

Since 2007, Roux has been managing director, chief investment officer of JB Were with specific responsibility for managing Australian and international equity portfolios.

Previously, she held roles in strategy and business development

Andrew Black at the Coles Group, and in equity analysis at Citigroup, MacIntosh Securities and Merrill Lynch.

PATRON Financial Advice has appointed a Victorian state manager as it looks to increase its footprint on the eastern seaboard.

Sharon Cummins was most recently Victorian state manager for Australian Financial Services and has over 18 years industry experience, according to Patron.

Cummins’s responsibilities will include the recruitment of planners and risk advisers; practice management support of these

Opportunities FINANCIAL PLANNER Location: Melbourne Company: FS Recruitment Solutions Description: This financial planning business is currently offering an opportunity to an experienced paraplanner with the Certified Financial Planning accreditation to progress into advising.

You will be responsible for providing comprehensive advice to clients and help grow the client base by servicing existing clients and potentially establishing external referral sources.

Ongoing training and education is on offer, as well as an established client base, increased earning potential and opportunities for progression.

For more information and to apply, please visit www.moneymanagement.com.au/jobs or contact Keira Brown at FS Recruitment Services – 0409 598 111, kbrown@fsrecruitmentsolutions.com.au.

PARAPLANNER/ ADMINISTRATOR Location: Sydney Company: Patron Financial Advice Description: An Australian Financial Services Licensee located in Paramatta is seeking a paraplanner/administrator to assist a number

OMNIWEALTH has appointed a new director, Matthew Kidd, as part of the firm’s plan to drive business growth and diversification.

Kidd brings 13 years experience across finance, operations and management. He most recently served as a director of privately held business at Grant Thornton Australia. Prior to that, Kidd was the director in charge of Accru Financial Planning for seven years, servicing high net worth clients. Kidd was also the senior development manager (NSW/ACT) at Adelaide Bank, where he was mainly responsible for money market inflows.

In his new role at Omniwealth, Kidd will be responsible for the implementation and analysis of growth strategies including corporate development, national expansion, and new partnerships credit team.

For more information on these jobs and to apply, please go to www.moneymanagement.com.au/jobs

of financial advisers in the day-to-day tasks of writing new business and servicing their clients.

You will be responsible for all limited advice plans submitted through the AFSL, and for administering databases for a panel of financial advisers.

To be considered for this role, you will have a Diploma of Financial Services, at least three years experience, strong communication skills, medium to high IT skills and the ability to work as part of a team.

To find out more about this opportunity and to apply, visit www.moneymangement.com.au/jobs or email Katrina Conyers, Operations Manager, Patron Financial Advice – operations@patronfa.com.au.

RELATIONSHIP MANAGER – COMMERCIAL Location: Adelaide Company: Terrington Consulting Description: As a result of portfolio growth, a tier one bank now has a vacancy for a senior relationship manager.

Working with a team of corporate bankers based in the Adelaide central business

district, the successful applicant will be responsible for servicing an existing book of corporate clients while identifying opportunities for further portfolio growth through the introduction of new product solutions.

As a proven business or commercial banker, you will have highly developed cashflow lending skills that will enable you to take a longer-term view and tailor solutions accordingly.

To find out more about this position and to apply, visit www.moneymanagement.com.au/jobs.

BUSINESS DEVELOPMENT MANAGERS Location: Perth Company: Terrington Consulting Description: An Australian-owned bank with over 200 retail outlets across metropolitan and regional Australia is looking to appoint experienced and relationship-driven business development managers.

These BDMs will be able to work autonomously and be responsible for building their own networks through the development and management of key relationships.

Applicants with a proven track record of driving expansion with minimal supervision

are encouraged to apply. The new opportunities are the result of significant expansion plans, and these roles offer impressive earning potential.

For more information and to apply, visit www.moneymanagement.com.au/jobs or contact Emily – 0422 918 177, emily@terringtonconsulting.com.au.

PRIVATE WEALTH ADVISER Location: Melbourne Company: Helm Recruitment Description: An independent planning firm is seeking a financial adviser to fill a new position. The role involves promoting a full service offering to high net worth (HNW) clients, including financial advice, retirement planning, client administration, stockbroking, lending and life insurance.

To be suitable for this role, you will have a strong background as a private wealth adviser, and hold a relevant financial services qualification such as a Diploma of Financial Services or the Certified Financial Planning accreditation.

For more information and to apply, visit www.moneymanagement.com.au/jobs or contact Brendan Jukes at Helm Recruitment – (03) 9018 8001.

www.moneymanagement.com.au September 15, 2011 Money Management — 27

Outsider

“

A LIGHT-HEARTED LOOK AT THE OTHER SIDE OF MAKING MONEY

Lycra alert – calling all cars IT is well known that Outsider has an absolute aversion to lycra unless, of course, it is worn by athletes such as those competing in the women’s 100 metres at the World Championship.

Notwithstanding his deeply ingrained aversion to lycra, Outsider has nonetheless thrown his support behind financial services stalwarts, Ray Griffin and Peter Bobbin, as they cycle their way from Bourke to Sydney in aid of the Future2 foundation. They finish tomorrow (Friday 16th), but it is not too late to back their efforts.

Outsider is not only enamoured of the cause for which

Griffin and Bobbin are cycling, he admires the fact that two men who are old enough to know better should embark on such a journey year after year.

Indeed, he well remembers their arrival in Sydney in 2010, when Bobbin was carr ying an injur y which would have sent lesser men to bed looking for an aspirin

and a good rub.

It is because of this that the normally heroic Outsider (he wouldn’t shout if a shark bit him) has decided that he will join with Money Management’s managing editor, Mike Taylor, in sponsoring Bobbin, and he encourages other readers to also get the moths out of their wallets.

At the very least, he figures Bobbin and Griffin should regard the sponsorship as an encouragement to refrain from unnecessarily wearing lycra in public places.

Indeed, the next time he sees Bobbin and Griffin, Outsider hopes that they will join with him in celebrating the comfort of a good Harris Tweed.

SMSF rent-a-crowd OUTSIDER may be a little vague when it comes to his personal affairs, but one thing he is reasonably confident about is where his superannuation is invested.

Unfortunately, the same thing cannot be said for some of the respondents to a recent Investment Trends survey on the state of the self-managed superannuation fund (SMSF) market.

To weed out participants who believed they were a member of a SMSF when the reality was quite different, the Investment Trends researchers included the question ‘How many members does your SMSF have?’ If the response to this question was in the tens of thousands, the

researchers knew they could safely screen the confused participant out of the survey.

The reality, of course, is that the average number of members in a SMSF is somewhere between one and two.

Perhaps there is something to the idea that Australians aren’t as engaged with their super as the industry would like to think.

Still, Outsider shouldn’t be too critical. We all have certain things in our lives that we like to delude ourselves about.

After all, Outsider spent many of his formative years under the mistaken impression that he might one day play representative rugby.

Positions vacant: Ruthless Dictator/stenographer OV E R h i s m o re t h a n t w o score years and 10, Outsider has observed many advertising and promotional campaigns around the sale of life insurance, but an effort published in national daily newspaper last week took the biscuit.

Forget about those mindless television advertisements which bastardise the lyrics of otherwise perfectly acceptable songs in the hope that

you will change your car insurer, the message in the advertisement published by lifebroker.com.au was very simple and, to Outsider at least, suggested the company c o u l d o r g a n i s e c ov e r f o r almost anyone.

It simply stated “Life insurance?” beside a picture of o u s t e d L i by a n d i c t a t o r, Muammar Gaddafi.

Now Outsider doesn’t know that much about the intrica-

cies of life insurance, but he i m a g i n e s t h a t h i s c u r re n t circumstances place Gaddafi rather high on the risk scale.

A s s u c h , i f l i f e b ro k e r c a n , indeed, find some coverage for this erstwhile popular leader he may need very deep pockets to pay the premium.

Then, too, there is the quest i o n o f h ow t h e i n s u ra n c e applicant would describe his current employment – retired or between dictatorships?

28 — Money Management September 15, 2011 www.moneymanagement.com.au

Out of context

"The accountant's exemption does not appear as vexed an issue as asking planners to go through the 'communist' idea of getting their clients to opt in every two years.”

Shorten showing he is well aware of some of the criticisms around the more contentious FOFA reforms.

"I'm joking; I don't think it's a communist idea".

And a quick retraction from Shorten perhaps worried about being quoted... "out of context"...

"That was one of the great speeches, and I've heard some real crap over the years."

Co-founder of FinaMetrica, Paul Resnik, shows his appreciation for public speaking at an FSC/Deloitte lunch in Melbourne.