Is internalisation the best way forward?
It was surprising to hear that one of the Platinum Asset Management’s top performing managers, Joseph Lai, Portfolio Manager of the Platinum Asia Fund, had left the firm over Christmas. The fund had performed exceptionally well in 2020 and was a highlight of an otherwise difficult year for the ‘value’ shop which saw the trend of outflows continue.
Yet the decision could say more about the investment management industry in general, and the importance of having ‘skin in the game’ when it comes to investing. Anyone involved in funds management knows that capitalism rules. The nature of the financial world makes it an extremely stressful place, requiring long hours, significant travel and a willingness to go above and beyond to get an edge over one’s competitors. It is this dedication that means the most successful investors tend to want to start their own firms or share more closely in the profits they are delivering to their supporters.
In many ways, the Australian industry fund sector is bucking this trend, by seeking to internalise more and more investment decisions. For instance, Australian Super, the country’s largest fund, aims to have 50% of its total assets managed in house by June 2021. That would be some $150 billion of their projected $300 billion in assets under management.
There are of course clear benefits of internalisation, with the ability to control and reduce costs the most powerful. The ability to replace fund managers charging anywhere from 0.5% to 1.0% of assets with internal, salaried teams at a fixed cost allows super funds to keep their administration fees low. Similarly, other ‘asset owners’ as they are known, highlight the ability to control the execution and implementation of trades, better leverage with those external managers they continue to use and new deal and information flow among the other key benefits.
As many benefits as there are, there clear drawbacks and questions around performance management and accountability. For instance, how do you remove an underperforming manager when they are employed on a salary? Do you scrutinise internal management teams as closely as you would an external one? How do you reduce the administration and human resource issues that arise in employing hundreds of investment professionals in a single firm?
Harvard Endowment is a case in point for what can go wrong when the sole focus is on cutting costs and managing all assets in house. Generating returns above most benchmarks is difficult, to do so consistently is generally limited to the smartest and brightest in the industry. Most importantly, there is only a few small group of truly great managers, and none of these people will ever manage money for a single group.
Whilst the publicly reported remuneration packages of industry investment professionals are significant, and likely close to market value, it is the inability to share in the profits and losses of their decisions that stands out. Most investment professionals are educated in a world seeking outperformance, not benchmark performance, and naturally believe they have the skills to deliver. It is for this reason, that the retention of quality investment managers by large institutions will likely become increasingly difficult in the years ahead.
This may just be an opportunity for the financial advice industry. The internalisation process, which has typically been focused on replicating index or benchmark returns, combined with the recent Your Future, Your Super legislation, may force the industry into becoming ‘benchmark beasts’. The legislation is effectively targeting those funds who underperform these benchmarks, suggesting they should merge over time to create a stronger industry. If this proceeds despite extensive and warranted protestations from various lobbying groups, it will add to the growing number of differentiating points for financial advisers and further level the playing field in superannuation.