Frontier Advisors will lift out State Super’s investment team in exchange for a 23 per cent shareholding in the business as it looks to set up what it believes will be an independent and unconflicted investment offering for clients across super and wealth management.

“This goes to making more of the market here,” Frontier Advisors CEO Andrew Polson tells Investment Magazine.

“We’ve dealt with State Super for more than 20 years as a client, and we’d been thinking about how to build out an end-to-end investment solution set that we could offer the small-to-mid-size institutional market.”

On paper, it’s a win-win for both organisations. State Super, with three quarters of its members having progressed into retirement, was conscious that it was not facing the future growth prospects of other large super funds (and likely also that its investment team, headed up by Charles Wu, is well-respected in the market and could well get itchy feet).

And Frontier, like many other asset consultants, has been pondering how to broaden its service offering at a time when many funds have brought the functions it once performed for them in-house. That’s led to it moving deeper into the wealth, endowment and foundation segments and opening an office in Japan to push into that market and South Korea.

There are a couple of trends that will support the growth of the new venture, Polson says.

“We could see that custodians were starting to exit that part of the market, which was meaning that a lot of clients that loved our advice weren’t able to execute it,” he says.

“That was going to be a problem for them. Equally, as we looked at those small-to-mid-size institutions, some of them don’t want to run all of the investment operations risk in-house. For some of them, investments isn’t a core part of their business, and if they lose a key person in the exec team, on the investments side or on the board, that sometimes creates a huge operational problem or risk for them.”

Small super funds – these days, sub-$30 billion, though Polson nominates sub-$2 billion as one of the areas Frontier wants to play – are finding it harder to access both custody (they’re less attractive to the global players when base fees are charged as a percentage of assets under custody) and merger partners. The very large funds are unwilling to spend a lot of time and resources picking up comparatively small amounts of assets under management, while so-called ‘mergers of equals’ with similarly sized peers are unlikely to produce a new fund that is competitive in APRA’s eyes.

That’s raised the prospect of some funds effectively becoming stranded, unable to access the larger unlisted investment opportunities that have boosted the returns of other funds, and with dwindling membership bases to boot.

State’s custodian is J.P. Morgan, and it’s unlikely they’ll go anywhere soon. It’s possible that Frontier will stick with J.P, though Polson says the business is still “working through the detail” of what it will do and is in discussion with a number of providers. He expects that dealing with “one Frontier” rather than a host of investment minnows will be more attractive to a big custodian, but also wants to leave room to accommodate any funds that already have arrangements in place.

“We think it’ll be super flexible, and we’re conscious that infrastructure of platforms and custody is going to keep changing, so we’ll want to put something in place that can be flexible but which is differentiated from the competition,” Polson says.

Frontier is dubbing the service “independent CIO” (ICIO). Sceptics will call it implemented consulting by another name – a path that Frontier has so far avoided going down, even as other asset consultants have taken it to get closer to the money. Polson says that where Frontier’s offering differs is that there will be no product conflict.

“It’s still an advice-led independent service. But where the client chooses not to operate their entire investment spectrum in house, we can support them,” he says. 

“We think that’s a customer centric way of doing it… We want to disrupt the product and implemented consulting business out there, which we don’t believe really produces portfolios that are designed for those clients, and we see those examples all the time.

“What we see from a lot of OCIO solutions is that they have house product as a part of what they execute. ICIO is an advice-led proposition that’s supplemented with our investment capabilities.”

As part of the deal, State will get a 23 per cent stake in Frontier, diluting existing shareholders AustralianSuper, Cbus, HESTA and First Super, which believe the new venture will be value accretive enough to offset their diminished holding.

“We think it offers shareholders really good upside in the valuation of Frontier. And so, effectively a very low capital intensity deal from a shareholder’s perspective, but being slightly diluted by offering State 23 per cent of the company, but with substantial upside from a valuation perspective that well and truly overcomes that dilution.”
 

And Polson says that the new venture – which he thinks will ultimately see Frontier double its domestic headcount –  should be engaging enough to retain the investment team.

“They know us, and we know them. I’ve talked to them a lot about the prospect of the business. It is different, and gives them a really clear path in terms of how to grow a new business and participate in that growth,” Polson says.

“We’re keeping them close together and maintain them up in Sydney. We’ll take some office space from State Super and they’ll remain pretty close to home in terms of still feeling a part of State Super despite the fact that they’re now working with Frontier.

“But it’s about giving them the opportunity to experience different sectors. Other super funds, the insurance sector, the wealth sector are all things they’re interested in. Obviously we can repurpose that capability for other markets. We do expect that this solution set can be used in Japan, which is exciting for them as well.”