Innovation in the Australian Managed Funds Industry

Eric McNamara looks at the innovative EFG product launched by actuaries in the 1960s and at the evolution of the managed funds industry in Australia.

Today, Australian managed funds are quoted at around $2 trillion, having doubled since 2007. According to the Deloitte Super report, superannuation system funds are expected to reach around $8 trillion by 2033. There have been many developments in our industry that have facilitated this growth. These range from regulation, innovation, needs based and taxation driven steps to fuel our staggering managed fund system asset growth.

A managed fund is any investment vehicle where the underlying assets (stocks or bonds for example) are selected by the fund manager and the investments are pooled for the benefit of all investors, with each investor holding an interest in the fund. They choose the assets for you and charge a fee for doing so. These funds could be actively or passively managed (or somewhere in-between). Or, as in some cases, the fund could be a “fund-of-fund” structure where the investment firm chooses a selection of fund managers rather than particular stocks or bonds.

Australia is no stranger to innovation; whether it be our system of compulsory superannuation contributions or our global lead in developing investment structures. Along this vein, I would like to focus on a managed fund from 1965, namely, National Mutual’s (later AXA, now AMP) “E-F-G” diversified fund. However, to begin, I shall give some context of the period in question.

The early managed funds (as covered in the IFSA/KPMG 2005 paper titled “Fifty years of managed funds in Australia”) were very basic in nature. They primarily were unit trusts in shares or property.

Units were offered to the public in the First Australian Unit Trust in 1936. It was referred to in its prospectus as ‘modern method of scientific investment’. The table below (from the same IFSA/KPMG paper) shows the basket of shares within the First Australian Unit Trust.

EFtAnother notable early investment vehicle, the Universal Flexible Trusts, was founded in 1955 under the guidance of an actuary. These early noted funds and others were progressive as they allowed investors to hold units in a basket of shares which prior to this was impossible.

By the early 1960’s life offices were offering managed funds for superannuation investing. These funds were mostly backed by interest-bearing investments and tended to have much lower expected return than equity type solutions. Therefore, the insurance industry had to innovate or lose business to schemes that could offer a higher expected return.

Then in 1965 came the EFG fund. They key players were Huntley Walker (Assistant General Manager), Ken Dodson (Senior Investment Officer) and Ron McDonald (Superannuation Manager). These actuaries developed the EFG fund to solve the current urgent issues of the time described above. The initial use was exclusively for superannuation but that would change over time.

EFG was a huge step forward for life offices and for broader Australia. EFG had its own life office statutory fund and it was subdivided into the different asset classes. “E” for Equity units made up of shares and property, “F” for fixed interest and “G” for the then mandatory Government sector investments. Very early on they realised they needed to split out shares and property so the three asset classes became four.

Clients could now choose their asset allocation and invest in a diversified asset holding with monthly unit pricing. This was unheard of anywhere else in Australia at the time. Not only was a new approach to life office investing being born, clients were making asset allocation decisions.

Given that asset allocation is attributed to contributing arguably up to 90% of total performance (depending on the study), this was a huge leap forward in Australia’s superannuation investment maturity.

It took some time for clients to get comfortable with the choice of Equity units. This is quite remarkable when you think of all the choices we have today. Today’s concept of a default eases this choice burden but certainly does not remove it.

Not only did EFG change the nature of investing with insurance companies but it changed the way we think about investing. In the 1960’s there was not the investment industry of today and all our asset models to enable efficient and informed asset allocation decisions. For the first time, life office customers had to think about asset allocation and risk appetite. Today risk appetite is an industry in itself. We have witnessed the rise of the insurance CRO in terms of the mandate of the role and the importance within the Executive structure of firms.

Today diversified managed funds are nothing new. Daily unit pricing is standard and division of obligations into separate statutory funds is how our industry operates. Investment choices are greater than ever with specialist Hedge funds, Private Equity, Low Correlation funds, Catastrophe Bonds and Managed Futures (to name a few) all being available. When considering, for example, core long-only equity funds, the number of providers is mind boggling.

In addition, after over fifty years of managed funds dominating the wealth management landscape, technological innovation is driving a move towards direct ownership and exchange traded vehicles. We are seeing strong growth in investor directed portfolio services that allow investors to tailor investment strategies to meet their individual needs, including tax management. Often these self-directed managed funds will utilise the expertise of a fund manager, but the stock holdings are held directly in the name of the investor. We have also seen the rise of Exchange Traded Funds (ETF’s), with an increasing level of specialist structures. It is possibly too early to say, however, given the current trends it appears that the popularity of managed funds is on the decline. We can certainly deduce that competition in this space will become fiercer over time.

The Australian Managed Fund journey continues.

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