Q&A with Morningstar’s Ramsin Jajoo about hard ‘truths’ for managed funds ______

Blog / 30 Jun 2016

Sarah Hayward, Managing Director - Head of Australia and New Zealand

It helps to be agnostic in today’s investment management sector, as capital flows more freely and broadly across classes, borders and structures.

Sharing our bird’s eye perspective is global investment research group Morningstar, whose Head of Asset Management Solutions Ramsin Jajoo recently addressed our Connect Forum in May, highlighting three “inevitable truths” as shaping flows.

First. Fees really matter, if an active fund is not in the cheapest quintile (within cheapest 20% of their category), it will struggle (1)

Second, passive is winning over active in the debate. The move towards increased use of passive/low cost solutions is gaining traction across all markets.

And Third. Advisers will continue to seek investments that help to reduce volatility (in the hope of providing a better client experience) and make their business models more valuable (better earnings and cash flow certainty). So the rise in the use of alternatives and other multi-strategy solutions is likely to continue into the future.

I spoke with Ramsin to discuss how these truths are translating to flow movements and the trends we’re seeing in Australia, and globally.

Q. Managed fund and ETF assets are slightly down globally, but almost doubled their pre-GFC volume, what does this tell us?

We have seen assets across all classes double since the GFC, which more than anything highlights the power of compounding growth (Figure: Industry Assets Declined in 2015) and the fact that for many the GFC is a distant memory.

In Australia (Figure: Australian Industry Assets remained flat in 2015 but strong growth) retail assets (retail funds and ETFs) have almost doubled since the GFC as well, rising from A$600 billion in 2008 to almost A$1 trillion in 2015.  Assets flattened in 2015 taking into consideration both market volatility and net inflows.  We saw net US$2 billion inflows into Australian assets, with alternatives experiencing the most relative growth.

Q. Australia and New Zealand (Oceania) make up 3% of global assets (based on market capitalization) but we have one of the largest investment management industries in the world?

In terms of asset management, Australia is the 3rd largest market, due to 30 years of mandated superannuation. 75% of the assets that sit in the Australian asset management industry are superannuation and pension assets. According to Morningstar Direct (Morningstar’s institutional research platform) there are over 6,000 retail superannuation and pension investment options available in Australia. In contrast, in some European markets such as Italy, whilst there are 30,000 open end funds or UCITs available to investors, there are only 611 pension funds or investment options available for retail investors. Similarly, the UK market only started their mandated employer based pension system in 2012, mandating contributions at around 2%, but they have plans to increase the minimum level over the coming years to 8% from 2019 onwards. So on a comparative basis, Australia is a very mature and sophisticated market.

Q. Almost half of assets in Australia are invested in multi-asset funds, eclipsing the global average, why do you think?

On a global scale, allocation solutions (multi-asset) make up 11%, but in Australia just over half the assets are invested in allocation/multi-asset funds.  This is a testament to the pension system in Australia where a large part of the default superannuation contributions is invested in multi-asset options. In the early days of super, asset consultants would provide asset allocation strategies for defined benefit funds, but once the retail market emerged (including a burgeoning adviser market), it was quick to adopt the research practices used by institutional consultants for defined benefit schemes. This includes using a “balanced” asset allocation strategy to smooth returns, so the retail industry became sophisticated early on by understanding the benefits of a 60% (stocks) / 40% (bonds) asset allocation, to manage risk and return for clients. Even as DIY investors move away from default options, one common practice continues to be a core (multisector funds) and satellites (specialised and high alpha options) approach to portfolio construction.

Q. One of your “truths” is that wealth management businesses are seeking investments that reduce volatility to improve client experiences and protect business value, can you expand on this?

Alternative strategies can help dampen volatility and provide investors a smoother investment experience.

The other key benefit is that the less volatility a wealth management business’ assets under advice experiences, the less its earnings are impacted. So for wealth managers that are listed, such as Perpetual, IOOF, the more volatile their earnings, the more their share price is impacted. Firms may be using more alternatives because they want more certainty in earnings.

Regardless of market movements, advisers need to pay for software, staff, rent etc. If they continue to invest in high risk high return strategies in volatile markets, they’ll likely incur a poor client experience and generate less predictable revenue. They want consistency on earnings by considering alternative investments such as long/short equities, managed futures and unlisted property, that are less correlated and more attractive for smoothing out return with lower volatility.

Return is a function of risk, getting a better risk-adjusted return is a win-win for everyone.

Q. Another “truth” is about low fees are critical, how is this playing out in terms of fund flows?

Take a look at Vanguard which had A$3 billion flow out of its pooled retail fund in 2015, but into a Vanguard (lower cost) mandates and ETFs. The other big trend in Australia is people are moving to direct securities. Money is also moving into more passive investments, be it pure index or strategic beta. The strongest growing market in the world over the past couple of years, based on year on year percentage growth, has been the Australian ETF market. This trend is primarily benefiting from investors’ preference for lower fees and investing in direct ASX-listed securities.

Q. What effect are mandates having on managed funds?

Looking back over the last 25 years in Australia, according to the Morningstar database 16,000 new funds were developed and 8,000 funds were rationalised. For a small population such as Australia’s, I’d say this is one of the most hotly contested managed funds industries in the world. The large size of asset pool and our mandated pension system attracts a lot of global asset managers. Despite product rationalisation, the number of new products have doubled over this period.

In recent years, dealer groups and platforms are applying scale to negotiate lower cost mandates. It isn’t uncommon for some larger dealer groups to negotiate equity mandate fees to be less than 30 basis points, whilst when I started in the industry, mandate fees were more than double this amount. However, markets go in cycles, as an advice business grows and dealer groups corporatise, opportunities become available for advisers to break away from the big dealer groups and set up smaller shops. However, smaller businesses don’t have the scale to demand mandates, so they use platforms and retail funds again. However, we definitely have noticed the trend that advisers are either using more passive strategies, ETFs, or mandates to drive down the cost of investments for their clients.

Q. Where are we at in the growth cycle for sustainable investments? Globally and in Australia?

In Europe, sustainable investments are growing at a very rapid rate. At Morningstar we’ve had European private banks come to us requesting more analysis and insights with respect to the sustainability of Fund Managers’ portfolios based on what securities they’re invested in. This trend in Europe is being driven at the investor level in private banks. The US is also catching on. We’re seeing increased interest in ESG within wealth management businesses.

In Australia, our asset management industry was one of the first to have a large cross-section of asset managers sign up to the UN PRI (2). But it hasn’t really got down to the investor level within wealth management, it is still in the space of industry super funds and at Board levels. Whilst a large number of asset managers suggest that they already consider ESG factors as part of how they select stocks, it will be interesting to compare whether such portfolios do in fact provide better sustainable outcomes or even offer better long term returns.

Fund flows and demographic shifts indicate that sustainable investing has the potential to grow into a major component of the market, considering the appetites of everyday investors. For example, women, millennials, and Generation X investors have expressed strong interest in this approach.

Whilst the value proposition for advisers may be limited today in Australia, we could see a time where an adviser many say, ‘Mr and Mrs Smith we’re not just looking after your retirement portfolios for today, but we’re also investing with fund managers that are delivering more sustainable investment strategies to ensure your estate and grandchildren have a better outcome over the long term’.

Q. How does Morningstar view sustainability?

Our Sustainability Rating isn’t about how “green” a fund is – it’s a broader measure of how well the companies a fund holds are handling important Environmental, Social, and Governance challenges compared to other companies in the same industry. We consider all three types of factors important. Environmental factors may include a company’s climate impact, energy efficiency or waste management. Social factors may include a company’s labor standards, gender diversity or how it treats its employees. Governance covers issues such as how a company pays its executives or what kinds of political contributions it makes.

We’re not making an ethical judgement on what’s good, what’s bad. We want to provide investors a new “sustainable” portfolio lens so they can make more informed decisions.


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1. Based on a Morningstar study of US Active Mutual Funds during the period 2003-2015.

2. Principles for Responsible Investment.

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