For the past four years, and usually around this time of year, funds managers and other professional forecasters have been warning Australian super funds to prepare for single-digit returns. One year, quite possibly this one, they will be right.

The performance of the Australian share market is still the singlemost- important influence on total fund returns notwithstanding a general dip in allocations as super funds adopt a greater diversity of lowly correlated investments. And this is also notwithstanding some years, such as last year, when the biggest decision investment committees had to make was whether or not to hedge their US dollar exposures.

Inevitably total fund returns will come back much closer to their strategic targets of 4-5 per cent above inflation, whether it’s this year or next. In such an environment, it has also been predicted for several years, super funds will be more keen to eke out smallish cost savings or added value across their portfolios. In this regard, at least, the forecasters have been proved correct. Big funds are putting more emphasis on the overall efficiency of their investments. They have reduced the cost of beta dramatically, they have improved the management of their cashflows and foreign exchange, they have looked at ways to minimise tax and now they are looking at combining portfolios to further reduce transaction costs such as brokerage and market impact.

In all these endeavours, custodians have a crucial role to play. However, they do not have the market to themselves. Investment banks, in particular, are encroaching on the investor services companies’ turf through the expansion of securities lending and transition management services. Some investment banks are offering ‘free’ custody of equities for long/short managers in return for prime brokerage. Similarly, some managers and multi-managers are offering emulation and master manager services. The lines between service providers are becoming blurred.

The most significant development in the marketplace concerns the potentially dramatic reduction in the cost of implementing a fund’s investment strategy through the combination of its discretely managed portfolios. First tested in Australia from 2003 by Russell Investment Group for its locally domiciled international shares fund, the full service is generally referred to as ‘master manager’. Russell simply replicated the buy/sell decisions of the managers for this fund but implemented those decisions more efficiently. In the two-year test period, cost savings averaged 28bps.

MLC was the first to market an emulation fund, in 2005, in a venture with Vanguard Investments. Vanguard last year introduced its own master manager service, called centralised portfolio management (CPM), with Victorian Funds Management Corporation as a key client.

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