The ‘master manager’ concept has captured the minds of super funds looking to eke out more savings in the implementation of their investment strategies. GREG BRIGHT reports.

The launch of a master manager service by NAB Custody last year marks potentially the most important change in investment administration in two decades. While super funds have expressed a lot of interest in the service, which promises savings of up to 100bps, they are being cautious about committing themselves. Mercer Sentinel, the largest specialist consultant in Australia, is currently reviewing the offering for clients.

Lounarda David, regional director of Mercer Sentinel Asia Pacific, says: “The master manager idea is a great initiative. It’s good to see that custodians are looking outside the box of traditional custody and investment operations space, and into areas that historically have been investment managers’ responsibility.

It also means that someone will be acting in some form of investment management capacity, looking at the investments at a consolidated level, trying to reduce unnecessary turnover and also making sure that at that level transactions are executed efficiently and cost effectively, both from a trading and tax perspective.”

She says that it actually takes the definition of custodian to a new level. “If they’re doing master manager, emulation and propagation, what do you call them? Custodians?” John Treloar, head of NAB Custody, says that the master manager and other new services represent a natural progression for super funds to improve the efficiency of their operations. “It is also a natural progression for custodians to better leverage their capabilities and add more value for clients. None of this is really new. We’re just putting together all the pieces much better and in the end it’s the members who are the big winners.”

Each of the custodians which have super fund clients is watching the space with interest, although NAB appears to be most advanced with a product. NAB is hopeful of having its first super fund in a pilot program in the first half of this year. NAB Custody held a series of presentations in November. Patrick Liddy, the director of marketing and strategy, and Vicki Martyn, head of product development, said that master custody was the “basic engine” for custodians, which had not changed much in 25 years.

They predicted that, just as with the introduction of master custody, it would take about five years for the new implementation services to be widely adopted by institutional investors. For NAB, there are three different services being offered. When combined with overlay programs, they are similar to what QIC refers to as ‘omega management’.

NAB is offering the capability to build ‘emulation’ funds, provide a full master manager service or provide a ‘propagation’ service. The emulation funds are index funds which are built to replicate the return characteristics of a group of active managers. MLC built Australia’s first one of these, which Vanguard implements. The emulation funds can outperform the manager portfolios even though they transact after the underlying managers.

Vanguard has in turn provided a master manager program, which it calls Centralised Portfolio Management (CPM), with VFMC its first client. Master manager goes a step further and takes only the buy and sell orders of a fund’s underlying managers and then constructs a single portfolio on a more efficient basis, using internal crossings and other techniques to save on costs.

Liddy said that accounting firm KPMG was commissioned to analyse the impact on a large super fund which had $4 billion in Australian equities. He said the fund would save $20 million a year, consisting of $14 million in tax savings and $6 million in brokerage. More difficult to quantify savings will come from reduced market impact through the off-market crossings, reduced cash drag and better foreign exchange transacting. “We think that the market will end up with a hybrid model, using master manager for some but not all of a fund’s total investments.

There are some asset classes which won’t fit,” Liddy said, such as the less liquid asset classes. The propagation service involves tax parcel selection for optimal results. For instance, when a stock, such as BHP, is held by multiple managers the tax parcel that most reduces the tax to be paid will be used, particularly delaying capital gains tax beyond the 12-month rule where possible. Martyn said this would not prevent a taxable event from occurring but the savings would still be significant.

Mercer Sentinel’s David says that some managers may resist the master manager proposal because it could potentially have some impact on managers current processes, but more importantly it disrupts their traditional relationships, particularly with brokers. However, the unbundling of transaction broking from research, which has been predicted for years, would alleviate some of the concerns.

Traditional brokers are likely to resist it as they did with directed brokerage programs. David says that the contractual arrangements for the master manager will be important and there will be a need for regular cost analysis to know whether the trading performance is acceptable – probably by a third-party provider.

However, Liddy says that NAB has already spoken with a lot of managers and about 90 per cent would agree to participate if the client wanted them to. “We would have been happy with a lower success rate than that,” he says. “But managers also agree there should be as little leakage as possible.”

Clearly, some super funds and multi-managers will have more influence than others in this regard. The potential ramifications if the master manager idea really takes off are much greater than the incomes of some brokers and funds manager dealers. The master managers could represent massive new ‘dark pools’ of liquidity – those sources of stocks and bonds available for off-market trades. Dark pools are expanding faster than exchanges in Europe and the US, which has been one of the prompts for the M&A activity among exchanges over the past few years.

If super funds were to pool their assets, at least for some of the cost-saving activities such as crossings and transition management, the master manager concept could similarly affect other traditional businesses. While most of the early attention is being focused on Australian equities, there is no reason, in theory at least, why master manager could not be used across all asset classes.

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