Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
What’s going on in custody: a big shift in fees for record year
A massive pipeline of securities servicing reviews has developed which will make this year the most significant for changes in more than 10 years. Coupled with the reviews are reductions in prices which question the sustainability of services to super funds and managers.
Custody and securities servicing reviews are known to be underway for: TWU Super; the Australia Post super fund; GESB; UniSuper; CARE; EISS; and AIG. These follow last week’s confirmation that Cbus will change providers, from NAB Asset Servicing to JP Morgan Investor Services, for the first time since the fund’s inception in the 1980s.
A senior executive of one of the largest custody providers said that one of the major players would need to exit the market – and fairly soon – for viability to return to the sector. Price reductions are unprecedented in the current cut-throat environment.
The risk is that securities services companies do, as the major fund administration firms did in the 1990s and early 2000s following pressure on their prices, which is to stop re-investing in their systems and service improvements for an extended period. It was only after consolidation in that sector that new investment in systems was re-established.
The custody executive, who did not wish to be named, said: “The funds are saying they’d like a new relationship which will enable them to adapt to the uncertain future environment, including handling new retirement income products, member-directed options, new complicated investments, more unlisted stuff etc. and that’s great. But when it gets down to the last two or three providers they just focus in on fees and the other goals seem to go out the window. I think they’re doing themselves a disservice over the medium-long term.”
A relatively new development is a request for a “fee holiday” of a year or so and then, depending on the size of the fund, an overall charge of less than one basis point. The fee “holiday” is worthy of separate analysis. Like the commercial property sector, fee “holidays” only have value for customers who can appreciate the immediate cashflow, often to the detriment of their longer-term position. Transaction costs are usually charged separately. If there’s one problem super funds don’t have it’s cashflow.
For the providers, the main areas of flexibility that remain are foreign exchange trading and cash. Cash rates paid by the custodians for short-term deposits left in their care, however, have also increased in the past two years to be much closer to the official rate than previously, cutting into the custodian’s margin.
With respect to the pipeline of reviews, the first ones to be finalized are likely to be GESB and CARE. GESB is being advised by Thomas Murray, the UK-based advisory firm, and CARE by independent Drew Vaughan, who also advised on the recent Cbus review. Brett Elvish, another experienced independent, is making a return to the fold, having in the past couple of years concentrated on advising managers on their various activities. He is advising Australia Post and is believed to be down to a short list of JP Morgan (the incumbent), Northern Trust and State Street. With TWU Super, Vaughan is also advising and NAB is the incumbent.
