There is vigorous industry debate about matters like whether alpha can be reliably harvested through skill, how much is really ‘beta’ (forms of return from systematic risks in the market) masquerading as alpha, whether funds can justify the fees for pursuing active programmes and whether alpha is big enough to cover the extra taxes a super fund must pay. At the same time, some super funds are pursuing increasingly ambitious plans to insource their investment management.
Behind these headlines, other insidious issues are putting pressure on the business models of active managers. One is the fragmentation of the needs of their super client base – in the ‘old world’, a manager could run a homogeneous set of mandates for different clients, creating operational efficiency, reducing risk and providing a scaleable business platform for managers. Some could combine these into a single pooled trust vehicle for the ultimate in convenience from a portfolio management perspective. The ‘new world’ requires managers to be equipped to meet the increasingly custom needs of their clients. As super funds grow larger, they increasingly shun pooled trusts as each asks for their own separate account. Then the custom requests begin to proliferate: one super fund client has a particular ESG screen or tilt to incorporate into their mandate; a different fund wants to dictate how proxies are voted; another wants separate mandates to run their accumulation and pension pools; another, hyper-sensitive to cash drag, severely restricts the percentage of the mandate that can be held as cash; yet another asks for the mandate to be managed against an after-tax, not pre-tax, performance benchmark. And the list goes on.
In this new world, it is the super funds who have scale, business smarts and sophisticated investment thinking and are using these to wrest the balance of power from active managers. It would be a mistake for active managers to think that, in response, their choice is limited to either clinging to the old world or catering to the new world of ever-proliferating custom demands of their super fund clients. There is a third course, which for an active equity manager represents an important strategic option, called Centralised Portfolio Management (CPM).
CPM recruits a specialist implementation manager into a traditional multimanager equity structure. Each active manager is a partner in the CPM solution, along with the implementation manager. Each active manager has a clear job to perform, much like the old world – to conduct research and develop insights about what combination of equities are likely to outperform a nominated pre-tax benchmark (e.g. S&P/ASX 200, MSCI World); that is, generate alpha for their super fund client. Where CPM differs is that instead of each manager implementing their insights by way of trading their own portfolios, without knowledge of or coordination with other managers, the managers each hand off the actual implementation to a centralised, after-tax-focused manager so that the trades can be optimised and implemented in a single equity pool.
In terms of old world/new world, what a business-savvy active manager should realise about CPM is that in handing off the implementation, they also get to hand off the customisation requests and complexity that come with the fragmenting needs and objectives of their super fund clients. The active manager’s world becomes largely homogenous again, in focusing on a single deliverable across clients – pre-tax alpha. This shifts the manager’s business model back towards a platform of scaleability, risk reduction and operational efficiency, instead of being pulled inexorably toward the increasing custom proliferation and complexity of the new world. When a super fund client requires an ESG screen or tilt, it becomes the CPM manager’s job to implement this in the centralised portfolio. To centralise proxy voting, this too becomes the CPM manager’s job to implement. Accumulation and pension asset segregation? Cash management? After-tax benchmarking? Factor tilting? Transition management? Operational Due Diligence compliance? RG 97 reporting? All these become the CPM manager’s job (in fact, most come as standard deliverables in the CPM structure). Each change has no impact on the underlying active managers, who remain singularly focused on generating their best-ideas alpha portfolio … in fact, there is no reason for the underlying active managers to be aware of these changes.
None of this is to suggest that there are no changes to be navigated by an active manager moving to become a partner (participant) in a CPM solution. But we caution against managers focusing only on the changes that CPM requires, without comparing these to the pathway of client mandate fragmentation and complexity that the new world otherwise represents. With a broader, more strategic perspective, active managers in Australia may well follow the lead of their US counterparts and come to view CPM as a short-term stranger, but long-term friend.
Raewyn Williams, Managing Director – Research, Parametric Australia
