The 20-year old ‘master custody’ model has several glaring inefficiencies which could be fixed by the custodian creating an emulation fund for each asset class, last month’s Conexus Financial Absolute Returns Conference heard.
In the words of NSW Treasury Corporation’s senior manager of investment facilities, Jonathan Green, there is a lot of “neglected beta” left behind by the traditional master custody model, and it’s extra return that requires only “marginal skill and marginal levels of active risk” to access.
Under existing fund administration arrangements, each funds manager deals with its own broker to execute trades, leading to unnecessarily high brokerage and forex charges, and higher capital gains tax liabilities, Tony O’Grady of admin consultancy Corporate Value Associates told the conference.
There was a duplication of record-keeping due to the master custodian dealing with each manager individually, and inefficient use of cash due to the need for separate liquidity pools to be maintained by each manager. O’Grady said the ‘master manager’ concept – basically a combination of netting, tax propagation and portfolio emulation performed at the master custodian level – would address these shortcomings.
In essence, O’Grady said the ‘master manager’ approach separated investment ideas from their implementation, establishing separate pools of assets at the asset class level (rather than lone manager level), allowing netting off of positions to save on brokerage and optimise tax outcomes, and providing for the simplification of accounting and greater purchasing power (for services like custody or even for commanding higher interest rates on cash) due to the consolidation.
NSW Treasury Corporation’s Green said that tax optimisation needed to be driven holistically by super funds, and could not be optimised “merely by buying a product or style” at the funds manager level alone. Green said the franking yield on the ASX 200 was around 4 per cent, which grossed up equated to 1.5 per cent or more. “It’s there but it’s not reflected in the beta,” Green said, adding that effective management of CGT exposure had been “under the radar for 20 years”.
Calling tax “an annual concept in a mark-to-market world”, Green suggested that an after-tax mindset be woven into a super fund’s governance structure and be a priority for the CIO and all front office staff, rather than merely an operations concern.
Green urged index providers to create a passive after-tax benchmark to be used as a basis for industry efforts, with at least a full grossing up of franking credits (or withholding tax for offshore investors).
