The complexity of the average super fund's organisational structure can have a limiting effect on the fund's ability to adapt and evolve, writes Parametric's Raewyn Williams.
As the superannuation industry faces ongoing scrutiny, one allegation is that funds have proliferated the choices available to members and introduced complexity into these choices, hence some funds now speak of a 'complexity budget' which describes their limited ability to change and evolve.
It makes sense for these funds to seek out innovative solutions that make it easier to implement change and make the complex simple. Solutions which reduce structural and operational complexities give the funds a bigger budget to implement changes and adapt to members’ evolving circumstances.
What kind of solution can lighten the load, simplify a fund’s investment arrangements and provide a platform for fast, nimble investment restructures and changes as the fund moves forward?
One solution is centralised portfolio management (CPM), which coordinates a portfolio’s multiple equity managers into a centralised single implementation account designed to help to maximise efficiencies.
Because this is a high-end, holistic solution, it might tempt funds to put it as an end step in its change programme, but funds managing a complexity budget should actually think of CPM as a logical first step.
CPM can be seen as a best-practice, efficient implementation structure that positions funds to implement an ongoing change program in a way that minimises the tax and transaction costs of change, delivers the changes quickly and easily and provides a whole-of-portfolio view to the fund pre- and post-change.
Here are five examples of how CPM can work to free up a fund’s complexity budget to pursue further change and innovation.
1. The fund launches a risk project to understand how much true diversification it has across its equity managers, based on stock-specific, industry, sector and factor exposures. The fund also wants to understand how much the net combined exposures of its active managers differ from a passive portfolio. Is the fund really just getting an expensive ASX 200 or MSCI World ex Australia portfolio?
In a traditional multi-manager equity structure, this can be a complex exercise of obtaining data from multiple sources and in different forms, putting the 'jigsaw pieces together and then conducting analysis on the picture that the jigsaw reveals.
This can be resource- and time-intensive and the data can become stale the longer it takes to complete the exercise.
In a CPM structure, it is a single request to one manager (the CPM manager), who can run the analyses on the whole CPM portfolio and answer the fund’s questions easily and quickly. In some cases, the information can be included in the fund’s regular monthly performance reports.
2. The fund decides to introduce two new equity managers whose allocations are funded by terminating one equity manager and halving the mandate of another.
In a traditional structure, a transition manager is hired, with multiple discussions with the impacted equity managers who are required to agree with and implement the transition plan. The transition will typically cost the fund in terms of tax (not managed in this scenario) and transaction costs.
In CPM, it is a single instruction to the CPM manager and notification to impacted managers; no transition manager is required.
The CPM manager manages the changes and can reduce transition timing and transaction costs by sourcing the securities in the new target portfolio from within the broader CPM portfolio without needing on-market trades. The CPM manager will also tax-manage any trading required to move to the new target portfolio.
3. The fund adopts an after-tax investment focus, consistent with its SIS Act obligations.
A traditional structure limits the fund to low-value solutions like tax lot selection, 'propagation'/ 'tax parcel optimisation' or turnover constraints on managers, or else the complex exercise of researching after-tax benchmarks and performance metrics, assigning these to managers and finding managers with after-tax skills.
Managers may make sub-optimal after-tax decisions despite their best efforts due to their inability to see the fund’s true tax position at the whole-of-portfolio level.
In CPM, an after-tax overlay is embedded and the individual managers are insulated from the need to change from their tried and true pre-tax strategies.
The fund continues to get pre-tax performance benchmarking and reporting in relation to individual managers and also gets pre- and post-tax benchmarking and performance reporting for the combined CPM portfolio, including attribution to the CPM after-tax overlay.
4. The fund segregates its pension from accumulation assets, due to its growing number of pension members.
In a traditional structure, the fund creates a separate pension investment mandate and portfolio for each manager, which can double the number of equity mandates to be managed and monitored.
Each manager must have the skill to manage the accumulation and pension portfolios differently and appropriately (eg, in relation to buy-backs, franking credits, liquidity, yield preferences, withholding tax, defensiveness and other expressed preferences).
In CPM, the managers’ mandates are unchanged and are not multiplied. Each manager continues to manage one ‘best ideas’ portfolio, provided as a model to the CPM manager.
The CPM manager aggregates the manager models to create one accumulation portfolio and one pension portfolio. These can then be managed separately by the CPM manager with no impact on the underlying managers.
5. The fund adopts a tactical factor-based strategy and also a 'no fossil fuels' policy.
In a traditional structure, the fund either physically reallocates assets between managers periodically to pursue the targeted factor position or hires an external overlay manager.
The fund also needs to change all the manager mandates and performance benchmarks to reflect its new fossil fuel-free philosophy.
In CPM, the CPM manager is an inbuilt overlay manager and can easily implement factor positions within the CPM portfolio.
Similarly, the fossil fuel screen can be implemented and monitored as a simple exercise within the CPM portfolio. The fund’s factor and responsible investing initiatives require no discussions with, and have no impact on, the underlying managers.
Even funds who want to thought-lead, innovate and evolve for the benefit of their members could be forced to simply shelve or delay good ideas like those listed above because they are limited by a 'complexity budget', or, they can adopt a solution like CPM which, by design, frees up their complexity budget by making it faster, simpler and less costly for the fund to implement change.
We encourage funds to examine their current desired change program and consider these two competing pathways: the 'jigsaw' of their existing multi-manager structure, or the cleaner, holistic implementation solution of CPM.
CPM does not add complexity to a fund’s investment arrangements and plans but, in fact, makes simple what was complex.
Raewyn Williams is the director of research and after-tax solutions at Parametric Australasia.
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