I recently sat on a panel that was asked to talk through the challenges of distributing managed funds, in what is now a very mature and competitive industry.  During the discussion, one of my fellow panellist more or less said, “I hear you about the whole disruption thing, but the vast majority of our industry is invested through managed funds, and any disruption is a long way off.”  That is, ‘chill out bro, she’ll be right…’

On the first point, the panellist was dead right (managed funds still dominate the landscape with a massive $2.6t in assets).  But the tone of the thinking probably resembled the boardrooms of other industries that have been swept away in the blink of an eye.  Industries like the CD industry when looking at the threat of digital MP3 recording, the record stores, when looking at iTunes and Pandora, and Uber and AirBNB who are successfully disrupting the taxi and hotel accommodation markets respectively – the first response from the incumbents is usually a defensive “poor old me” approach.

In each case, the dominant models have been wiped out by new entrants that offer better customer value on important dimensions, or by more innovative existing players that have been prepared to change their model to fit the change in market preferences.

Where are managed funds being hurt the most?

Whilst the bulk of the industry’s assets are currently invested via managed funds, they are not growing in terms of net sales.  The forces against such growth are summarised below,

1. The $600bn SMSF sector (which was a mere pipsqueak 10 years ago) prefers investing in direct assets and listed entities ‘advised’ by tip sheets and media outlets,
2. Poor returns and relatively high ‘all in’ fees, of the benchmark aware long only managers across all asset classes (sold as ‘active’),
3. Administration hassles of having to buy and sell them,
4. Potentially poor tax outcomes,
5. The rise of robo advice (I mean true algorithmic investment platforms and not lead gen tools),
6. Higher barriers to entry for fund managers in establishing new funds,
7. Lack of transparency in the underlying holdings,
8. IFAs vertically integrating to become multi asset fund managers using managed account platforms and listed entities, and
9. Industry Funds insourcing what they used to outsource in traditional asset classes to drive down costs.

Given this backdrop, it is no surprise, at least in the retail setting, that emerging product structures are taking off.  And whilst small now, the high growth rates suggest that the market has spoken in terms of where the ‘puck‘ is going (make sure you read that twice).

New product categories that were largely non existent around the time that Y2K was going to end us all, include,

1. ETFs (including exchange traded managed funds), which now have $19bn under management according to the latest BetaShare report.  Incredibly (and yes from a low base), the CAGR of this product set has been 31% p.a. since 2004.
2. LICs, which in the September quarter reached $28bn in AUM, with more listings planned between now and the end of the year (e.g. Bennelong and 8IP).
3. SMAs – a new age managed fund but no longer offered as a unit trust, now exceeding $13bn in FUM.

Whilst these new product sets only have $60bn in AUM, they have managed to grow in an environment where the managed fund market has stagnated, according to the latest ABS June 2015 data.  The managed fund industry, given its size, is now a beta play on the performance of each asset class and not a net sales growth story (yes there are exceptions).

Interestingly, the above product segments are being offered by existing managed fund players in the case of the index ETFs (Vanguard, StateStreet, Blackrock etc), as well as innovative new entrants in Market Vectors and BetaShares.  In a similar vein, LICs have been offered by managed fund providers in the case of Platinum, Magellan and IML etc, in addition to managers that have small (or non-existent retail managed fund businesses) like Wilson, Metage and Cadence for example.

In the SMA space, the smart managers have worked out that the trend for transparency and beneficial ownership, driven in part by the ‘IFA as the investment manager trend’ , have started to offer their IP through the various managed account platforms, recognising the opportunity this sector provides.

As such, managers are providing multiple options for various investors segments to access their IP – a multi channel approach.

Further, with the advent of the mFund market, fund managers are now able to access the SMSF sector, without those investors having to fill in annoying AML forms etc.  Having NAB and Macquarie join the fray in the past month or so, means the future looks far better for this important development than it did six months ago.  (And to the management at CommSec?  I am peeved that I recently had to transfer my stock to a new broker that allows me to buy mFunds; time to get off your high horse please – I am sure you will miss the $10 you were making out of me each year BTW…)

In support of this growing product pool, the ASX now provides access to the following structures,

1. 126 mFund products with $67m in FUM,
2. 87 LICs,
3. 145 ETPs (ETFs and ETMFs), and
4. 58 A-REIT and Infra Funds.

So in this way, managed funds still have a fighting chance, even whilst the ETF, LIC and SMA offerings grab the lion’s share of the net sales growth.

Some assets may always be found in managed funds

In addition to the mFund market providing a new channel to sell existing managed funds and the development of exchange traded managed funds, some strategies may only ever (brave call) be available in a unit trust format, such as,

1. Long form PDS products (not currently allowed on the mFund exchange),
2. Offshore hedge funds, and
3. Strategies such as long short, market neutral, systematic quant, private equity, property syndicates and other private assets etc (all could be offered in an LIC though).

As a result, I agree that the managed fund market will not be disrupted away entirely but will simply house more innovative strategies that cannot be accessed in any other format (for now).

Where does this leave us?

1. Traditional managed funds will continue to decline in light of the above forces.
2. Managers are responding with new ways to offer their IP to meet the market’s change in product preference (e.g. SMAs, exchange traded managed funds, LICs, mFund listings etc).
3. New product sets are emerging that better fit the IFA as the investment manager (ETFs, LICs, model portfolios), and the SMSFs preference for direct investing.
4. Innovative strategies that house alternatives assets may last a long time in the managed fund format.

But because humans have a very poor record of forecasting past one day with any accuracy, I can only offer one ‘guarantee’ about the future.  And that is, in 25 years from now (when I will be living in a small run down French chateau), future panel members will be saying how the dominant model of direct investing (ETFs and LICs) will never die…

Andrew Fairweather, Founding Partner