It’s easy to get lost in the thicket of jargon. David Wright takes a machete to the undergrowth.We have written in this column before about some of the trends and changes in adviser and investor behaviour that have emerged since the GFC. However, one issue that deserves further scrutiny is the trend towards direct equities rather than managed funds for some investors’ Australian equities exposure. Again, just as the move from actively-managed funds to passively-managed funds is a common practice after any market downturn, in our experience so too is the move from managed funds to direct equities, as advisers and investors lose faith in their fund managers in a negative return environment. While this phenomenon has again occurred to some degree, the days of advisers managing direct equities portfo­lios themselves, or relying on a transaction-driven broker, are quickly diminishing, due to the higher portfolio administration requirements of direct equities, the rigorous compliance regime and greater focus on risk management generally.

DEFINITIONAL CONFUSION All this has led to a search for alternative direct equities solutions, which has coincided with the emergence over the past five to 10 years of individually managed accounts (IMAs) and separately managed accounts (SMAs). Despite this, the take-up of SMA and IMA services has been slow, and much smaller than many predicted based on the US experience. In Zenith’s view, there are a number of reasons for this, not the least of which is advisers’ lack of understanding of the differences between SMAs, IMAs and managed discretionary accounts (MDAs), with all three terms often being used, incor­rectly, interchangeably. To clarify, an SMA is a portfolio of direct stocks managed on behalf of investors. Each investor in the SMA holds the same stocks (subject to some trading cost rules), so when the SMA portfolio manager changes the portfolio, the change is made to all investors’ portfolios, irrespective of their capital loss or gain position or taxation consequences. This is because the SMA manages a model portfolio, with any changes to this central model portfolio reflected in each investor’s portfolio. On the other hand, an IMA, as the name suggests, is a direct equities portfolio managed by a portfolio manager specifically for that investor, and therefore will take into account capital gain and loss positions, incorporating tax implications on each stock and the overall portfolio for that client.

MDAs are totally different, and are defined by ASIC as generally being “arrangements that involve a person (an MDA operator) managing a portfolio of assets for a retail client on an individual basis”. This may or may not include direct stocks. Finally, the term “managed accounts” tends to be used to cover SMAs, IMAs and MDAs. WHO ARE THE PLAYERS? There are now a number of quality SMA, IMA and MDA administrators providing the necessary administration tools and platforms for investment managers to operate and manage direct equities portfolios for investors. The emergence and evolution of these administrators has led to an expansion of the number of managers operating SMA portfolios, in particular. There are now a number of recognised fund managers managing SMA portfolio versions of their unit trust portfolios for investors.

To date, the participation of recognised fund managers in the SMA and/or IMA space has largely been restricted to the boutique managers with little, if any, participation by the large, institutionally-owned managers. Given the infancy of the SMA and IMA direct equities portfolio structure this is understandable, as many boutique managers agree to manage SMA portfolios for investors as a vehicle to increase their funds under management and invest­ment management fees. Equally, it is easy to understand why some of the larger, established fund managers have not participated in the manage­ment of direct equities portfolios for clients. They are often reluctant to outsource administrative control of the portfolio to an external managed account administrator; dislike disclosing their stock holdings to investors; and are reluctant to dedicate portfolio management time and resources to such a small seg­ment of the market. The industry needs the large, successful, recognised fund managers to participate in the SMA and IMA segment of the market for it to gain greater legitimacy and growth.

THE CHARACTERISTICS AND ADVANTAGES There are a number of advantages and characteristics of direct equities portfolios that are managed in an SMA or IMA format for investors. Direct ownership The underlying portfolio of stocks is held directly in the cli­ent’s name, making the portfolio “portable”. That is, if the inves­tor is dissatisfied with the portfolio manager they can sack them and transfer the portfolio of stocks to an alternative manager, or manage the portfolio themselves. Tax Unlike investing in a managed fund, any taxation conse­quences resulting from a portfolio transaction are quarantined to the individual investor. In a managed fund, there may be embedded capital gains within the unit price that an investor “buys into” when investing in a fund. In addition, the manager may be forced to sell stock to meet other investors’ redemp­tion requests, resulting in taxation consequences for remaining investors, through no action of their own.

From this perspective, IMAs are the most tax-effective vehicles, as the portfolio man­ager takes into account the individual investor’s tax position on individual stocks and the overall portfolio, and may seek to time the sale of stock in order to minimise the investor’s tax liability. Given that IMAs are much more intensive for a portfolio man­ager to manage, they tend to be more expensive and reserved for only high-net-worth investors. Portfolio transparency In general, portfolio managers of SMA and IMA portfolios disclose in full to investors the stock names and weightings of the portfolio (sometimes on a delayed basis), while managed funds do not. Investors like to see what they own, so this tends to be a major attraction of SMAs and IMAs. Portfolio characteristics SMA and IMA portfolios tend to be a lot more concentrat­ed than managed funds in terms of the number of stocks in the portfolio, and as such are more in line with how an individual investor would invest themselves.