Category Archives: News

Winston Partners with Epsilon Direct Lending for Private Market Debt Fund

For release: 18 November 2020

Winston Capital Partners (Winston) has partnered with Epsilon Direct Lending (Epsilon) to distribute its Direct Lending Fund to financial advisers, family offices, managed accounts and high net worth individuals.

The Fund provides important senior debt funding to performing middle market Australian and New Zealand companies that are generating between $25mn and $500mn in annual revenue, and a minimum of $5mn in EBITDA. The loans are provided to support growth and event-driven strategies such as leveraged buyouts and acquisitions.

The Fund is targeting a total net return of BBSW + 6% with quarterly cash income of 3.25% – 4.00%, which in an environment where rates are close to zero, offers investors with an exceptional return from a defensive alternative investment that more than compensates for the illiquid nature of the strategy. The Fund does not lend to property developers or investors, biotech, special situations or turnarounds, start-ups or other risky segments of the market, instead, focusing on performing bilateral loans to high quality companies with high levels of security, which will suit more conservative investors in the private debt market segment. There are also considerable fee discounts for early stage investors in the Fund, offering a further return uplift.

Epsilon was created by the team that established Australia’s leading middle market corporate finance business at CBA, helping some of Australia’s most successful private companies grow and expand. Epsilon’s founders have personally originated, and individually structured and documented close to 50 growth and event-driven financing transactions amounting to over $1.6bn, none of which experienced payment defaults. The borrowers tend to be privately-owned companies that are large enough to require a bespoke financing solution, but not of a size to have meaningful access to funding from offshore or onshore bond markets or the broadly syndicated domestic loan market.

Andrew Fairweather, a Winston Founder said: “Epsilon was an attractive partner to Winston given that banks are exiting large segments of the lending market due to regulations and capital constraints, which will provide our clients exceptional risk-adjusted returns from what is a very attractive and hard-to-access segment of Australian private debt.

“Further, the Epsilon team created CBA’s middle market corporate finance business and have partnered with some of Australia leading private equity firms such as Quadrant Private Equity, Next Capital, Crescent Capital Partners, The Growth Fund and Advent Partners among others, as well as helping many well-known companies expand and grow. We believe there are very few ways for investors to access private debt in a lower risk manner that Epsilon are offering versus the multiple debt funds already in the market that are focused on property, SME lending or broadly syndicated corporate debt participation.”

Commenting on the partnership, Paul Nagy, an Epsilon Founder, said: “We are delighted to partner with Winston to provide wholesale investors access to a private debt investment opportunity that is generally unavailable to them currently. Our team has been operating successfully in this market for a long time and it is intended that the Fund will capitalise on our knowledge, relationships and experience as the lead financier to many transactions which, in most instances, involved us lending alongside investments from some of the best private equity investors and management teams in the market. The bespoke nature of the bilateral private loans we provide to middle market companies presents investors with the opportunity to diversify away from other debt investments and access attractive, predictable recurring cash income, with a capital preservation focus, that is not correlated to other fixed income and alternatives exposures.”

For more information please contact:

  • Andrew Fairweather, Winston +61 401 76 043
  • Paul Nagy, Epsilon + 61 401 918 209

About Winston

Founded in 2012, Winston Capital Partners is a retail focused third party funds management distribution business that seeks to partner with fund managers with long term track records and a sustainable investment edge in their asset classes. Since inception, the firm has raised over $1.25bn for its fund manager partners, with offices in both Perth and Sydney. The firm represents Coolabah Capital (Smarter Money) for short term fixed income and long short credit, Monash Investors for long short Australian equities, Realside for property and private debt, Primewest for property and RF Corval for Property.

About Epsilon

Epsilon is a non-bank lender and private market asset manager specialising in providing bespoke financing to high quality, resilient Australian and New Zealand middle market companies. Epsilon was established in 2019, by Mick Wright-Smith, Joe Millward and Paul Nagy as a purpose-driven and customer-focussed firm. Epsilon’s aim is to support the growth of middle market companies with financing solutions, while delivering stable returns for investors, in all cases operating with the highest levels of integrity, reliability, and transparency. Epsilon has offices in Melbourne and Sydney, Australia.

Making money from trends in financial markets – August 2018

Put simply, trends exist in financial markets across multiple timeframes, geographies and asset classes including bonds, stocks, rates, commodities and currencies; no matter where you are in the world and no matter what the asset class, powerful behavioural forces exist that cause trends to form, pushing prices beyond what Eugene Fama’s Efficient Market Hypothesis (EMH) might suggest an asset price should be.

Are markets efficient, in the sense that all public information is included in current prices?

As Seager et al April 15, 2014 suggests, “If this were so, price changes would be totally unpredictable in the sense that no systematic excess return based on public information could be achieved. After decades of euphoria in economics departments (There is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis, as M. Jensen famously wrote in 1978), serious doubts were raised by behavioural economists who established a long series of pricing “anomalies”. The most famous of these anomalies (and arguably the most difficult to sweep under the rug) is the so-called “excess volatility puzzle”, unveiled by R. Shiller and others. Strangely (or wisely?) the 2013 Nobel committee decided not to take sides, and declared that markets are indeed efficient (as claimed by laureate E. Fama), but that the theory actually makes “little sense”, as argued by Shiller, who shared the same prize! In the list of long-known anomalies, the existence of trends plays a special role. First, because trending is the exact opposite of the mechanisms that should ensure that markets are efficient, i.e. reversion forces that drive prices back to the purported fundamental value. Second, because persistent returns validate a dramatically simple strategy, trend following, which amounts to buying when the price goes up, and selling when it goes down.” Importantly, trend following strategies do not predict the movement of various asset classes, instead, they make money profit from trends when they are securely in place.

To read the guide, please click on this link.

10 Million+ Australians Have More Than 30% of the Superannuation Invested In Alternatives – June 2018

Over the past month, we have reviewed the holdings of some of Australia’s largest Industry Super funds using their June 2017 accounts, to understand more about their approach to investing in alternatives, including hedge funds, private equity etc.  The reason we did this analysis, is because we often hear from advisers that only sophisticated investors should hold alternatives, and yet, a typical Hostplus member with an average account balance of ~$24k will hold ~$9k in Alternatives e.g. 37%.  These findings are consistent across all Industry Funds, whose asset allocation is fundamentally different to the standard retail advised portfolios that we review, whilst also being different from most research advised model portfolios.  Some of the reasons for not allocating may be valid (e.g. illiquid assets can’t be held, insurance limitations), but many are not (e.g. cash is my alternative, they are too complicated).

And following on from the Productivity Commissions review into Superannuation, there have been numerous articles in the mainstream press about why Industry Super Funds have continued to outperform retail funds over long periods of time.  Some of the reasons for the outperformance cited in the articles include,

  1. Superior asset allocation, here,
  2. Lower fees, here,
  3. More risk, here (shorter time horizon focus), and
  4. Access to the ‘Illiquidity Premium’ here, and here.
  5. (links to AFR articles require a subscription)

In truth, it is never one attribute that can explain the sustained outperformance, as it is more than likely a combination of factors. But to help advisers start to have conversations about Alternatives with their clients, we have put together a simple infographic to help make them more normal.

To access the guide, click on this link.

The Winston Capital Partners and ProCapital Guide To Forming an Investment Policy Framework – 22 May 2017

Over the past decade, numerous advisers have taken the investment management function in house, effectively setting up multi asset portfolios to better manage their clients’ wealth and better align them with their particular objectives. This trend has been well documented, and has resulted in the strong share price performance of most listed managed accounts providers, who are the key enablers that make it possible for advisers to offer their portfolios to the public, without the need for statements or records of advice.

For any adviser wishing to go down this implemented portfolio route, many issues need to be addressed, not least of which is the development of an investment policy framework that will form the basis on which their clients capital will be managed.  But an investment policy framework is more than that.  It is a document that should enunciate the competitive advantage of the adviser’s firm, whilst acting as both an internal and external communication tool.

To assist adviser’s get started on this important subject, both Winston Capital Partners and ProCapital collaborated to build a Guide that we hope will make the task a lot easier, than starting from scratch.

About the Guide

The Guide’s primary purpose is to assist advisers develop their own investment policy framework by taking examples from leading financial institutions here in Australia and overseas.  It is aimed at those advisers who are considering offering a standalone multi asset portfolio service using a unit trust or Managed Discretionary Authority (MDA) on a managed account platform but are not sure where to start.

It would not be possible to cover every section of policy framework in extensive detail.  As such, this Guide has been developed to offer examples of what should be covered in each section, recognising that consultants and research houses play a vital role in completing this important task.

To access the Guide, please click on this link.

(Please feel free to cut and paste sections of the Guide into your own documents – we want the Guide to be of practical help).

We welcome feedback

We know that there will be gaps in this document.  If you would like to contribute to future versions, please send me your suggestions to, and we will, to the best of our ability, incorporate them in future editions.  All work will be acknowledged.

Some easier steps along the path to in-house investment management – 8 February 2017

This article is a reprint from Professional Planner, which can be accessed by clicking on this link.

Over the last decade, numerous independent financial advisers (IFA) have taken the investment management function in-house, setting up multi-asset portfolios, supported by managed account platforms (but not exclusively so) to better manage their clients’ wealth. This trend has been well documented, and has resulted in the strong share price performance of most listed managed accounts providers, whilst advisers’ revenues have also risen, to the detriment of managed funds and traditional platforms, which are losing business to these new providers.

Four factors have converged to make the move to bring investment management in-house possible:

  1. The rise of nimble, hungry managed account providers with the technology, regulatory and administrative tools that make it possible for advisers to launch their own public offer, multi-asset portfolio services, for little capital expenditure
  2. The need for independent advisers to stay financially viable when competing with cross-subsidised institutional wealth managers, by providing a standalone, separately priced investment offer, considering Future of Financial Advice changes to conflicted remuneration
  3. The desire to lower investment costs in a competitive environment, which has led to an increased use of direct assets – including direct shares, listed investment companies, exchange-traded products, exchange-traded funds, real-estate investment trusts, bonds etc – which managed accounts typically favour over managed funds
  4. The rise of small, yet experienced consultants (as well as the traditional research houses), with experience assisting advisers with asset allocation policy settings and investment selection and monitoring.

Together, these factors have made it possible for smaller IFAs to vertically integrate, to the benefit of both their businesses and their clients’ wealth, without requiring a large capital expenditure. This trend will probably continue apace, and may even result in some large practices leaving the institutional wealth managers, as they seek to take more control over various aspects of their business.

Where do advisers learn to take this function in-house?

The transition from being an adviser using balanced or sector funds under a traditional financial planning model (e.g., issuing Statements of Advice), to one fully accountable for an implemented investment solution is not trivial. There are many decisions to be made (such as choice of managed account provider, mandate guidelines, consultants, etc.), and internal organisational changes to get right.

Most critical is the need to adopt a robust investment policy framework (IPF) that clearly enunciates the investment strategy the firm will adopt to achieve the mandate objectives. In our experience, there are few ‘off-the-shelf’ guides to walk advisers through a detailed process of setting up an IPF. Such a guide should include the adviser’s investment philosophy and beliefs, linked to a coherent set of investment policies, such as mandate objectives, allowable investments, asset allocation approach (static v dynamic) and ranges, selection and monitoring process, risk management and governance.

These factors all inform the investment committee in its decision-making, as well as serving as a valuable communication tool for clients and employees. The investment committee also needs a charter to ensure that the agreed upon parameters are followed.

To date, managed account providers have provided compliance-led policies and charters for advisers to use, as they are most at risk as the issuer of the adviser’s product disclosure statement. Many of these documents are boilerplate in their design. Furthermore, these policy documents are generally not available for public consumption, so advisers must work many of the details out for themselves, or appoint consultants or research houses to assist them in setting up the investment framework.

It’s fortunate that there is already enough publicly available information to assist advisers in starting to think holistically about the investment model they wish to adopt. See the Future Fund’s statement on its investment model as one example. Over the coming months, taking information from public sources – including industry funds, robo-advisers, sovereign wealth funds and dealer groups – Winston Capital, in conjunction with Professional Planner, will provide a guide to assist advisers in creating a robust investment framework (from compliance to competitive advantage) prior to engaging with any service providers.

In doing so, we hope to improve the management of client wealth in the retail sector in Australia, and give advisers an easy-to-use guide that takes high-quality examples of what is required to manage wealth in a complex operating environment.

What the defeat of Garry Kasparov by ‘Deep Blue’ tell us about the future of multi strat alternative funds – 26 April 2016

In fairness to Garry he did win the first series against IBM’s ‘Deep Blue’ in 1996 (4-2), only to lose in 1997 (3½ -2½); the first time a computer program had defeated a world champion under match tournament regulations.  You can read about it here or you can watch a video about it here.

But what has a chess player losing to a supercomputer (programmed by some pretty smart people) got to do with the future of discretionary multi strat hedge funds I hear you ask?  A lot, you hear me answer.

Definitional note

In this blog, I use the term ‘discretionary multi strat’ alternative funds to explain those products where teams of people devote their time and resources to fundamental research across asset allocation, manager/strategy selection, operational DD, and administration and governance etc, which are then packaged into convenient ‘all in one’ portfolios.  In contrast, the ‘systematic multi strat’ funds create ‘all in one’ portfolios but devote their resources to exploiting statistically robust anomalies, taking a ‘systematic’ approach by using big data and massive investments in IT (e.g. people, hardware and software), removing many human biases and beliefs, and where the implementation of trades are executed with the aid of supercomputers, in real time, and with little human intervention.  The humans, in this case, spend more time on data integrity, statistical analysis of various strategies, position keeping systems and in managing servers in their data centres etc.

Both approaches aim to offer significant diversification benefits by exposing investors to streams of lowly correlated returns that help to smooth the path of returns for investors – an important feature, as the advice market transitions (slowly) to objective/goals based advice.

But both approaches have vastly different return outcomes, as I highlight below in Table 1.

Disruption is everywhere you look

Not a day passes by without hearing or reading about the powerful forces of technological ‘disruption’. In financial services, most of the emphasis has been in relation to how robo advisers might disrupt traditional wealth management, how blockchain will crater investment banking and stock exchange earnings or in the banking sector, with peer-to-peer lending bypassing the need for banking channels to obtain credit etc.

Disruption is essentially about creating customer value (e.g. lower cost, safer flying, better manufacturing etc) at some point, in, or across, an existing industry value chain, or indeed, by creating a new value chain altogether.

But away from the media hype surrounding the death of the banks and financial advisers, a quiet revolution has been going on in the management of multi strat hedge funds, as the world’s best physicists apply their rigorous techniques to systematically capture lowly correlated mispriced anomalies, assisted by the ever growing power of supercomputers.

As Table 1 below highlights, the discretionary multi strat products managed by teams of people attempting to asset allocate and choose best of breed managers/strategies, has generally done a poor job of delivering against their product promises, with the exception of the Ibbotson Diversified Alternatives Trust. If the BlackRock retail fund can replicate the longer term performance of their wholesale fund, then it will also be included in the exception list – there is no reason to think that they cannot.

But when compared to groups like AQR with their Delta product and CFM with their alternative beta portfolio ISD that use supercomputers to systematically capture mispriced and lowly correlated market anomalies, the discretionary segment has been left for dead – completely disrupted into what might become future irrelevance. Like the discretionary segment, both AQR and CFM provide their IP in the form of diversified alternative solutions but here, they are offered at much lower cost, are liquid and transparent, and have far less ‘forecasting error risk.’

What is most fascinating about the discretionary multi strat segment is that there is wide spread acceptance of the disparity of returns between various hedge fund managers, within their field of expertise, supposedly making it easier to select best of breed managers or strategies – the evidence, on the surface, does not support this.  (And hello survivorship bias – the Select Alternatives and van Eyk Blueprint Portfolios are no longer in the peer group).   Knowing both funds well, I can safely assume that they would not have made it into the exception category.

Table 1 – Smart Human Failing to Deliver v Smart(er?) Humans Using Supercomputers that Do Deliver

Screen Shot 2016-04-30 at 12.30.08 PM

The BlackRock Fund has a wholesale vehicle that has produced a stellar 10.15% p.a. gross of fees return since inception in July 2004

** Marketed by Winston Capital (for good reason)

Obvious weakness in Table 1, include the different inception dates, no data on correlation outcomes (not provided by most managers), the loss of a number of competitors and the short time periods for some funds, however, LHP has been in Australia for over 14 years.  Its 10 year return is just 1.57% p.a., which is well below its inception date return (highlighting strong early year performance, as recent periods have been average) and well below the RBA cash rate over that same period.

A packaged alternative solution makes a great deal of sense

Conceptually, the idea of partnering with a fund manager to select the best fund managers/strategies makes a great deal of sense, given the global nature of the alternative fund market and the sheer complexity of the asset class.  Having people scour the world looking for alternative fund manager talent, given these factors, seems to make sense, but at what point will fund managers who offer these discretionary portfolios ask themselves “how much longer should we offer these underperforming portfolios to the public?”

And I should know. As the previous CEO of Select Asset Management, we used to market a discretionary ‘all in one’ alternative portfolio managed with a small team here in Australia that was well rated by research houses and listed on numerous dealer APLs and model portfolios, but we worked out that to offer better value to our clients, we needed a global team to manage it, and so, given that expense, we transferred the management of the fund to Neuberger Berman, but as Table 1 shows, this has not started off well.

It is no surprise that Alternatives are under represented in retail portfolios

Based on our estimates, less than 4% of retail FUM is allocated to the alternatives asset class, with most of that invested in managed futures – strategies that are great for providing tail risk hedging (hello supercomputers!) but not so great at providing returns when in sideways markets, characterised by intra period volatility or at critical market turning points.

But is it any wonder, given the results of the discretionary multi start funds to date that advisers have avoided these funds – the FUM in some of the funds is below breakeven.  For advisers that have used them, they have been on the back foot ever since with their clients. For those that have exited altogether, many now use cash as their ‘alternative’ asset – the path of least resistance.  Cash doesn’t blow up, is easy to explain, is liquid, preserves capital etc – explainability plays a big role in product choice but I’m arguing to not throw the baby out with the bathwater (who would do that BTW?) and take a fresh look at the disrupters like AQR and CFM, as a compliment to their managed futures positions (slight overlap).  Or indeed, as a new way to re-enter the asset class but with more confidence.

Many advisers are scared off by what they consider to be ‘black box’ investments

What’s scarier? A plane that takes off, flies and lands by itself carrying 100s of passengers with the aid of sophisticated software programs, or programs that systematically capture lowly correlated mispricing opportunities that actually work using the same computational power?

Neither are scary; they are both simple examples of how technology is used to reduce human error and do a better job – both still need smart people to make them work though (for now…).

And far from being ‘black boxes’, these new strategies are ‘white’ in colour – we know what goes in, and we know what comes out – it is not a mystery, as full disclosure is offered to investors.  The ‘trick’ as it were, is in trade execution and data management i.e. connecting the PhDs, with the supercomputers, to the market exchanges – this is where massive amounts of capex is spent by the likes of CFM and AQR, and the managed futures providers in Winston, Aspect and Man AHL.

For example, CFM collect 2.5TB of data each day (the equivalent of a typical academic research library), have more than 1,500 servers, monitor over 1,000,000 instruments on a daily basis, nearly half of their employees are IT engineers, and in total, they have invested over €100m in sophisticated IT systems over the past decade.  AQR would have made similar investments in delivering their expertise to market, if not more, given their size.

Needless to say, the barriers to entry in the systematic multi strat segment are as high as the discretionary multi strat funds – perhaps higher (disruption does not come cheap here).

Where to from here?

It is my hope that advisers take a fresh look at the diversification benefits offered by the systematic multi strat funds offered by the likes of AQR and CFM, where supercomputers, programmed by smart PhD, consistently deliver on their product promise of generating returns from lowly correlated mispricing anomalies, thus, providing important diversification benefits to client portfolios who are looking for smoother pathways in the management of their wealth.

In a world where fixed income returns are so low, providing little real income and with the future potential of rising inflation and hence capital losses on fixed rate bonds, advisers need to consider how best to achieve portfolio diversification at low cost, and in a liquid format.  Fixed income may not deliver like it has done in the past.

And as M. Turnbull might say, “there has never been a better time to invest in diversified alternative strategies that actually work for investors.”

Andrew Fairweather, Founding Partner


No one at SSGA read the marketing dept memo… 27 January 2016

Last week was quieter than normal in the Winston office, and clearly, I had way too much time on my hands given the article below, but I have to say, I felt compelled to pen a short blog on how large companies sometimes struggle to stay on message, causing confusion with potential customers because of conflicting messages about what they truly believe in.

The cause of my confusion, and probably the principal cause of confusion for many investors who rely on the media to make their ‘informed’ investment decisions, was SSGA’s 24 hour press release cycle suggesting why on one hand, we should invest in ETFs during times of high uncertainty and high volatility (apparently this is what investors do during times of market stress based on SSGA’s sales observations) only to be told 24 hours later by the same brand suggesting why investing in benchmarks may not be such a good idea.  Huh?

In the blue corner, we have the SSGA ETF team weighing in at 93.5kgs…

January 19, 2016:  “ETFs benefit from market volatility” 

Screen Shot 2016-01-27 at 4.42.16 PM

SSGA’s ETF team suggest that “during times of market uncertainty many investors want (or need) to remain invested in the sharemarket, but higher levels of uncertainty make it more difficult to identify opportunities.”  This seems odd.  I would have thought that the greater the uncertainty, the greater the opportunity set. My last post highlighted how a number of ‘true to label active managers’  are doing very well in these uncertain times – you can read the blog here.

The article goes on to talk about STW, the S&P/ASX 200 ETF, which is a massively concentrated portfolio that derives the majority of its return (beta) from a small number of economic drivers, unable to avoid them because there is no view being expressed in these products. Thus, as the banks, BHP, RIO get smashed, losing billions in value along the way, we are expected to believe that more investors flock to ETFs, which is contrary to behavioural finance evidence and net flow data (see Dalbar reports) going back decades that suggest investors bail out during times such as these.   In fact, the article shows how bad this ETF can be (not great marketing I might add) when it goes on to say, “in fact, this year, our local share market has had one of the worse starts on record with only a handful of stocks on the ASX200 rising. Even Australia’s banking sector, which up until recently has been relatively immune from major global economic shocks, is showing signs of stress with shares in Australia’s largest bank, CBA, falling below $80 in January this year from a peak of $96 in March last year – that’s a 17% loss.”

Yep – by being in this ETF, you just dusted 17% in CBA; a 10% (high conviction) position in STW – a potentially avoidable loss (on paper) by thinking about where we are in the credit cycle…

And in the red corner, we have the active side of the business, weighing in at 93.6kgs…

January 20, 2016:  “equity benchmarks too risky amid volatility

Screen Shot 2016-01-27 at 4.42.07 PM

What?  I just got told by SSGA that investors look to ETFs during times of uncertainty and high volatility (or at least they want you to believe this), but this SSGA presser says that this is not such a good idea – who should we believe?

Well because the 20 January (red corner) article conforms to my own investment biases, I have to applaud this part of SSGA’s business because it sensibly “urge(s) investors to ignore benchmark weights in favour of a truly active approach amid recent and likely on-going market volatility.”

Yes, you read it right (or was that left)…

And when commenting on the market uncertainty they, “characterise (their) outlook for global markets in 2016 – lacklustre growth, risks skewed to the downside, likely fuelling bouts of investor uncertainty and market volatility.”

As a result of this outlook, the team in the red corner suggest that, “like in 2014 and 2015 we believe that to add value over the coming year we should ignore the benchmark weights and truly be active” because “the Australian equity market is dominated by financials and commodity-related sectors in terms of market capitalisation and for benchmark-driven investors this could continue to create a drag. These sectors were a significant drag on risk-adjusted returns of the benchmark index over the past twelve months, and we believe will continue to add volatility and may depress returns for the year to come.”

So whom should we believe?

Well, the red team’s active share fund has delivered 5.6% p.a. in after fee alpha since its inception in 2009, and has done so with less risk than STW – the highly concentrated index fund… (The numbers don’t lie people).

Where to from here based on this Pulitzer prize winning journal entry?

The truth of the matter (depending on your point of view), is that both products make sense at certain times.  The weighting toward passive ETFs and active managers really depends on where we are in the investment cycle.  In my view, at this stage of the investment cycle, loading up on ETFs may not be that sensible, but if you believe we are in for a multi year bull market, then maybe they are the place to be.  If you believe that we are in for more uncertainty etc, then having some smart managers picking the eyes out of the market to avoid those sectors that are at risk of further losses, also makes sense.

As they say, horses for courses…

Andrew Fairweather, Founding Partner

Could all true to label ‘active’ managers step forward please; your time has come – 7 January 2016

2015 was a pretty tough market for Australian equities and the benchmark hugging managers that track the various indexes, however, some managers had stellar years, significantly outperforming the market (and with less risk). This was especially so in the absolute return space (long short), but even there, the return dispersion between the various managers was large, and as a segment, there is enormous variance in the strategies and product structures available making it difficult to develop a standardised peer group.

And 2016 hasn’t started any better (the rain in Sydney has been nice though – not), as fears mount about China, energy gluts, geopolitical worries everywhere and the US bull market drawing to a close – but everywhere I go, there is a growing trend for IFAs, using managed accounts, to use 100% ETFs to manage their client portfolios – this strategy, thus, relies 100% on the ICs of these groups to make correct asset allocation calls, as this is the only source of value available to them – how many great asset allocators are there, and do these models just rely on SAA with the occasional tilts or are they truly dynamic?  And if everyone is using the same forecasting models, or the same inputs from external providers, then most of these portfolios will be crowded in the same trades, which may result in poor outcomes in times of market stress (like now).

So is it time to reconsider the role of true to label active equity managers in a client’s portfolio, and if so, how might they be used to complement the ETF approach?

My not so academic definition of active management

But before we get there, first a definition of what active management is not.

I do not consider (and this is a non-academic argument), a fund manager who has low tracking error, that hold all the banks, BHP,/RIO and TLS etc, as active. It is not like they can’t see where the risks are in these stocks but they chose to adjust their portfolios only slightly in response; that’s not being active – this is simply an open ended fund’s way of remaining open to new flows, as BDMs seek to gather as many assets possible (rewards are linked to these activities), irrespective of the return impact on end investors – career risk plays a major role here for the fund managers of such funds. And unfortunately, most of the surveys that prove that active managers do not add value, include these type of funds – how can they add true alpha over time in this environment?

The rise of the absolute return managers is cause for celebration given my whinge about so called active managers

Over the past five to six years, a new group have emerged that have some important features (see below) – many are wholesale only but more and more are being offered to retail clients and are available on platforms.  Names such as LHC, Totus, Bennelong, Auscap, Wavestone and Winston manager, Monash Investors, are not afraid to deviate significantly from equity benchmarks, holding none of the standard names (potentially shorting them when it makes sense to do so), whilst also having an ability to vary the market beta to manage downside risk or be completely market neutral when it suits.  That is, these funds are managed by bright people, generally in two to three person teams, who have the ability truly express their views, using all of the tools that are now available to fund managers – they are not concerned about benchmark returns but in generating absolute returns. Equals, Active.

Features of these absolute return managers/strategies include,

  1. PMs with high IQs making more right calls than wrong over time,
  2. PM’s that simply cannot work in large institutions, although many have,
  3. Focusing on absolute returns and capital preservation and not on relative returns,
  4. Having mandate flexibility so that they can truly express their views,
  5. Capping the growth of the funds that they manage to focus on returns and not asset gathering (this feature generally comes with performance fees however),
  6. Having smaller teams with nimble decision making abilities,
  7. Not being locked into one rigid investment style, and
  8. Having the ability to hold cash, futures or by being both long and short to manage risk.

Examples of post fee 12 month returns to the end of November 2015 for some of these managers,

  1. LHC – 36.2%
  2. Bennelong Long Short – 32.8%
  3. Monash Investors – 16.6%
  4. Totus – 43.4%
  5. Auscap – 30.6%
  6. Wavestone – 14.1%

(SourceAustralian Fund Monitors)

What these numbers don’t tell you is the above managers’ gross/net exposures, the concentration of their portfolios and other such risks taken to get these results – this article is not for that.  It simply highlights that these absolute return strategies have produced very strong after fee returns in what was has been both a very flat and volatile market – all of the above had Sharpe ratios over 1.6 as a matter of interest over the past three years.  I also recognise that the above is a ridiculously, and arguably meaningless time period in which to judge a manager/strategy, but I use it to highlight what can be generated when the market returns are so weak. BTW, the three year numbers for the listed managers are also very compelling.

And by highlighting the post fees text in bold, I simply highlight that these funds are more expensive than the benchmark huggers, but investors have been well and truly compensated for the higher fee load.  Active management, can justify higher fees.

The non academic but intuitive active test for dummys (that would be me)…

To ascertain whether these new products are truly active though, it makes sense to review the top ten positions versus a standard index before worrying too much about the other features one would expect to see in this space.  It is a very rough guide but it is intuitive.  To me, if you see the same name as your ETF provider and with similar weights, it might be best that you move on.  Often, the large wealth managers launch new products to capture investor demand but their absolute return portfolios can look remarkably similar to their mainstream products – this is not a philosophy but a way to generate sales.  Avoid. The absolute return segment is currently dominated by true to label boutiques.

What role might these new funds play?

I have written extensively on the rise of ETFs over the past couple of years – I am a major supporter, notwithstanding the comments made above about asset allocation being the only source of value for those groups using them to manage their clients wealth, but if the so called active managers continue to hug their benchmarks, then they deserve to lose sales to the ETFs (hello disruption). Therefore, the new age funds, could be used to complement ETFs providing ICs with two sources of value (asset allocation (beta) and true alpha) – stock level cross ownership should be low between most of these absolute return funds and the ETFs being used, and they may act as a great risk management tool when shorting is used or when the fund is completely market neutral.

For planners wanting to give their clients exposure to growth assets but with less risk (counterintuitive given how much more flexible the mandates are), the absolute return equity funds might be a place to explore – they are active, and based on the above, are worth the fees.  Further, given that most clients have their own direct stocks (my Daddy gave me these BHP shares, and his Daddy gave them to him (said in a Southern US accent for effect) and/or to complement ETFs, these new funds will give them exposures to companies that might be flying under the radar, and/or they may be shorting some of the well known direct stocks, which together, may act as a decent diversifying tool.

2016 – the year to review and change?

If planners are worried about equity market volatility, especially so for pre-retiree and retiree clients but still want exposure to growth assets but with generally less risk, then having some exposure to absolute return managers to complement ETFs and other direct holdings might add a lot of value in time.  The research houses have taken on the challenge of covering these new managers/strategies, either as part of their Alts reviews, or as a subset of the equities review – this will assist planners make the right choices, as these strategies can be more complex to explain.

My wish from here, is that as the domestic offerings continue to grow in time, and as planners gain a greater acceptance of these strategies, that we can get similar products for global equities.

Andrew Fairweather, Founding Partner

(Obvious disclaimer – Winston represents two absolute return managers in CFM (Alternative Beta) and Monash Investors (Absolute Return Australian Shares) – hopefully my inclusion of competitors in the above article will ease anyone’s need to vent their fury in my general direction, but feel free if it makes you feel warm and fuzzy).

Under Resourced, Under Appreciated, Under Paid and Over Worked. 23 July 2015

These comments may seem a tad shrill, however, it is my belief that the research task within the wealth management industry is currently under resourced, under appreciated, over worked and under paid, and as a result, not delivering to the extent that it could be, or should be.  I believe this to be the case, because in large part, many dealers see the role of research as a compliance function, rather than a unique source of competitive advantage.  As such, the function is considered a ‘cost centre’ versus a ‘profit centre.’

As a result of this constant pressure to reduce costs, Research Houses, (rightly from a commercial point of view), have fund managers contribute to their revenue line by paying fees to be rated (more on that later), by building multi manager products (e.g. van Eyk; and that did not work out so well) or by bundling services (Ibbotson and Morningstar) for their customers. All of these responses, to my mind, are natural, in an environment where the owners of these research businesses (and dealers who purchase their services) are privately owned (other than in Morningstar’s case, which is listed on the Nasdaq), and keen to grow their own shareholder value.

But when not resourced well, the issues that have been highlighted at IOOF can emerge. We have all read the press about the issues flagged within their research department, which has forced their MD, Chris Kelaher, to front a Senate Inquiry, whilst another individual has had his reputation left in tatters. Meanwhile, PWC have been appointed (no doubt at vast expense, post facto) to review the total research function within IOOF.  It’s a bad look, yet again, for our very fine industry.  But it would be folly to believe that the issues currently being investigated at IOOF, are not occurring elsewhere.

The issues highlighted in the case of IOOF may have come about because of the ‘cost centre’ mentality that is applied to the research role generally (e.g. did the research function expand to deal with the multitude of acquisitions?) Some other dealers groups that I know have less than two people doing full time research, serving 100s of advisers, and 10s of thousands of end clients, and they are under constant pressure to do more with less.

To summarise, provided below is my attempt to show the ‘flywheel’ in reverse in terms of the demise of research.

The Research Demise Flywheel in Motion

  1. Dealers do not see research as a source of competitive advantage – it is seen as a compliance function (‘cost centre’), hence, very few have enough internal resources to manage the sheer complexity of the research task described below, over relying on external Research Houses instead, who themselves, are capacity constrained.
  2. The ‘cost centre’ mentality flows down to the external Research Houses who have to survive on wafer thin margins to deliver a reasonable service.  To cover the bulk of their operating costs, they get fund managers to pay to be rated or build products – a flawed model – but what is their alternative? This shrinks the product pool to only those managers who can pay, versus all managers that should be given a chance to be rated (after sensible screening).
  3. Because margins are so thin – and I say this with the greatest respect, and with my economics 101 hat on, one of two things has to emerge.  Either, the talent pool is of a lower standard (relative) because the Research Houses are competing for talent against higher paying brokers, bankers or fund managers etc OR, they can pay top dollar but have to have smaller teams. Maybe the answer is in the middle.
  4. The end result? Lower quality of research in time, to the detriment of the end investor.


But why should this component of the value chain have such poor economics, if we consider what role the research function fulfil?  In summary, they have to be across global and domestic political and economic issues, have in-depth knowledge of the multitude of strategies available to investors (especially so in a ‘best interests’ world), know everything there is to know about fund managers in real time, emerging themes, product structuring, asset allocation, asset class valuations, direct equities, have views on ETFs, ETPs and LICs, specific fixed income offers, offer model portfolios and APL assistance, respond to individual adviser queries, do one off consulting jobs, research products not on the APL (a requirement of RG175) and the list goes on and on.  When we consider the tasks, we should all agree, that these are highly complex undertakings.  It is little wonder then, that one such research head decided to outsource the completion of his Kaplan tests, to one of his minions (joke of course – I have often considered doing the same…)

Why must they do all of these roles? Because the law states that this is what they are required to do.

Welcome to the lightest read you will review this year: Regulatory Guide 79

Regulatory Guide 79 Research report providers: Improving the quality of investment research is a ripper of a read.  The opening stanza begins, importantly, with the following,

  • “Research report providers are important gatekeepers, preparing investment research for retail and wholesale investors. The quality of this research has a significant impact on the quality of advice retail investors receive.”

Critically (and again, I am focused on the lack of resourcing in this function at the industry level), the following is highlighted in the guide,

  • RG 79.38 – The constituent parts of a high-quality research service are the human and other resources applied to the research task,
  • RG 79.75 – As the complexity of some financial products increases, it is essential that research analysts have the requisite skills and experience supported by an appropriate level of supervision and adequate sign-off processes to produce high-quality research.
  • RG 79.76 – Human resources are a key input to research report providers’ processes and output. Research report providers should allocate sufficient resources to support the effective performance of their research staff.
  • RG 79.79 – To analyse financial products well, research report providers need to allocate appropriate resources to each research task. This includes allocating sufficient numbers of staff with suitable qualifications for the research task and setting appropriate timelines for the completion of tasks.

But as an industry, I doubt this function is well resourced from a HR point of view to meet the objectives stated above and to do the role justice, (and the org charts of the major Research Houses covering each asset class are not large), again, because of the ‘cost centre’ mentality.

As importantly, Regulatory Guide 175 (and this was nowhere near as interesting as RG79 – the key characters and the plot were not as well developed in my view…), also provides some important considerations.

  • RG 175.310 Advice providers often use research produced by external research report providers to identify products that may be suitable for their clients. This research may assist in the development of approved product lists or in the preparation of SOAs. Advice providers are expected to make inquiries and research the products that they give advice on.

The way I read this, is that, it is fine to partner with an external Research House to develop APLs etc, but that is not enough – the dealer is also “expected to make inquiries“. But many dealers have a very simple APL process from a product manufacturer point of view (no doubt supported by a dealer’s insurer) i.e. ‘If you have an investment grade or above rating from any of the major Research Houses, you can approach our advisers.’… Is this enough given the complexity of the task, and in light of the takeaways from RG79 and RG175? No your honour, it is not.

Ian Knox (a.k.a Socrates), the MD of Paragem, was recently featured in Professional Planner Magazine (‘Why consistent research governance is critical for licensees and advisers‘, July 19, 2015) on this very subject. To quote the article, ‘Paragem outsources its investment research to Lonsec, only accepting products onto its approved product list (APL) that are rated “recommended” or higher by this research house. Investment managers with similar ratings from other research houses are not permitted automatic entry to its APL.’ Additionally, Ian then applies a “sniff” test.

“My background, and time in the industry, allows me to have a little bit of a common sense ‘sniff’, if you like, around what’s right and what’s wrong…you get a few warning bells,” [going on to say] that, “Part-time research is dangerous. Filtering it when you have suspicions about something is more sensible…I manage risks once [the products are] there.”

And thats the rub – part time research or indeed, not adequately resourcing the function, is “dangerous.”

Who is leading from the front in terms of research resourcing?

Amongst the gloomy outlook, there are many groups that have invested heavily in this important function.  At the big end of town, groups like Perpetual and Westpac/BT have considerable teams.  And at the smaller end, there are countless examples of IFAs who have appointed highly capable people to their ICs. Groups like Paul Melling Retirement Planning, WLM, Julliard, the IFAs in partnership with Select Investment Partners like DMG, Stonehouse, Profile and MGD, and those supported by Atrium, another well resourced team.

What is not surprising, given my knowledge of some of these groups, is that research is front and centre of their customer value propositions – it is not about compliance but central to advice and their revenue lines.  In short, a ‘profit centre’ and a source of competitive advantage – their profitability would suggest that they are on to something!

Where to from here?

  • Firstly, for the good of the industry, and counterintuitively, for better economics, Research Houses should no longer be able to accept payments from fund managers to be rated – the industry needs to be rebased. Because the industry is subsidised in a conflicted way (although there is no evidence that this is leading to any negative biases), it can never charge the true cost of providing research, plus a margin, to its clients. Having the function stand on its own two feet will focus the model on quality and the industry will know the true costs of providing such a service,
  • Secondly, the industry should consider having an internal ratio of people devoted to research relative to the size of their adviser force (but with some scale benefits) – as such, every time a major dealer purchases another dealer, the research function would no longer be an automatic ‘synergy’ benefit. These costs could be passed onto clients if the evidence that superior research is worth the money – it is my proposition, that it is,
  • Thirdly, dealers should not be able to just rely on their Research Houses to fulfil this task (remember RG175 – hard to forget really). They should be required to employ their own teams, in line with the second recommendation.  Where a dealer is small, it could work with other similarly sized groups to pay for this function, and
  • Finally, the industry needs to do a better job of showing how great research has avoided many of the blow-ups (more groups avoided Trio and Astrarra than invested) – those blows up that can kill reputation (hurting financially), result in customer exits (hurt financially), and result in litigation (hurt financially) etc. That is, moving from a cost centre mentality by providing hard data to show how valuable great research is, when resourced appropriately.

In conclusion – there are not enough human resources applied to research because the economics are so poor – this situation has been created by everyone trying to save money in delivering a reasonable service, resulting in Research Houses cross subsidising their pure function, alongside of dealers, who are also looking to save money in this area by “outsourcing” (abrogating) the research function.

In my view, it is time for change, and yes, that change may cost the industry more, but in doing so, it will lift the industry’s reputation.  From a cost centre mentality, to a source of competitive advantage approach because, “the quality of this research has a significant impact on the quality of advice retail investors receive.”  And who doesn’t want that?

Andrew Fairweather, Founding Partner