Review of the Managed Investments Act 1998

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 Submissions - Constellation Capital Management Ltd

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Improving Retail Investor Access to Specialist Investment Managers


Constellation seeks a minor amendment to the Managed Investments Act 1998 ("MIA") to facilitate improved retail investor access to specialist investment managers and thereby enable the managed investment scheme arrangements to operate more efficiently and effectively and with potentially improved protection afforded to retail investors.


Prior to the introduction of the MIA, retail investors were able to access the services of a specialist investment manager through the two-party structure. The retail investor invested in a managed investment scheme (i.e. a unit trust) established under an approved Trust Deed. That Trust Deed gave certain powers and responsibilities to a Manager and separate powers and responsibilities to a Trustee.

With the increasing popularity of master funds offered by retail financial services companies, retail investors gained access to the services of a wider range of specialist investment managers at wholesale rates.

Master fund managers used their bulk purchasing power to negotiate wholesale fees from the specialist managers. Specialist investment managers were able to offer lower fees because they did not have responsibility for, and therefore the associated cost of, marketing to or managing the retail investor accounts i.e. the activities and associated costs of specialist investment managers was focused on the provision of value added services of investment research and portfolio management. Master fund managers either appointed a specialist manager under an investment management agreement ("IMA") or invested in a wholesale pool managed by the specialist investment manager. The wholesale pool was constituted under an approved deed to permit investment by master fund operators but generally the manager of the wholesale pool did not need to issue a prospectus complying with the Corporations Act. This arrangement was efficient and effective.


Under the MIA, the two-party structure was replaced by the one party regime whereby the management and trustee functions were combined in a "Single Responsible Entity".

We understand the intent of the MIA is to provide improved retail investor protection and reduced costs, and that the single responsible entity is therefore the party to whom retail investors should look for investor protection.

Following the passage of the MIA, we observe that the great majority of retail and wholesale (specialist) investment managers have assumed the role of single responsible entity (RE) for managed investment schemes for which they were the investment manager. At the same time Trustees of those managed investment schemes have reluctantly retired from their fiduciary roles, as required under the Act.

We perceive that the rationale for such apparent enthusiasm for the RE role by investment managers derives from a related clause in the Corporations Act, (section 601FC(4)). Under this clause the responsible entity of a managed investment scheme offered to retail investors may only invest scheme property, or keep scheme property invested, in another managed investment scheme if that managed investment scheme is registered under Chapter 5 of the Corporations Act.

We note that managed investment schemes registered under the Act are required to have a responsible entity. Therefore the effect of this clause is to encourage specialist investment managers to become responsible entities so that they can continue to participate as a service provider to single responsible entities managing master funds i.e. by making their respective wholesale pools accessible to retail financial service companies who operate the master funds.

The MIA therefore encourages duplication of "single" responsible entities. At worst it may signal to retail investors the transfer of responsibility for retail accounts over to specialist investment managers.

This duplication has been heightened by the growth in popularity of master trusts. A master trust (or IDPS) operator promotes its master trust service to retail investors. Retail investors are offered a selection of funds through the master trust service. Those funds are required to be managed investment schemes (see ASIC Policy Statement 148, paragraph 52). The retail investor pays a fee to the master trust operator for the master trust service. These fees are in addition to the fees and charges paid by the investor in respect of the investment it makes through the master trust. Needless to say the fees and charges paid by the investor for investment in the underlying registered managed investment scheme reflect the additional compliance, prospectus preparation and other expenses which the responsible entity of that scheme is required to incur.

The investor has therefore borne fees at two levels without gaining access to the services of a specialist investment manager operating a wholesale pool such as our own.

Rationale for section 601FC(4)

It is worth reconsidering the rationale for section 601FC(4) in the existing environment. The rationale for the predecessor provision, Regulation 7.12.15(1)(a) was spelt out in ASIC's Policy Statement 55:

    "Regulation 7.12.15(1)(a) ensures that the protection afforded by Div 5 of Pt 7.12 is not diminished by the investment of scheme money in schemes that do not have approved deeds. The regulation prevents trustees and management companies avoiding the regulatory requirements of Div 5 by interposing one or more schemes with approved deeds between public money and investments managed without an approved deed"

We query whether this rationale is relevant in our situation. We are a specialist fund manager with a dealers' licence issued by ASIC. We have not set up a wholesale fund to avoid regulation as suggested in ASIC's Policy Statement. Regulation 7.12.15(1)(a) was enacted under the old prescribed interest regime. We question its ongoing relevance in the new MIA regime.


As noted above, under the MIA, section 601FC (4) requires that an RE may only invest scheme property, or keep scheme property invested, in another managed investment scheme if that managed investment scheme is registered under this Chapter 5 of the Corporations Act.

Constellation recommends that section 601FC(4) be amended in the case of any RE investment into an unregistered managed investment scheme that operates under the two party structure, where the Manager and Trustee are unrelated parties and the Manager holds a dealers licence.

Submitted for consideration and endorsement.

Doug Little
Managing Director
Percy Allan
6 September 2001

Malcolm Turnbull
Chair, MIA Review

Further discussion on the MIA follows.


Related Discussion on aspects of the MIA

Benefits of the MIA were said to be:

i) Improved protection for investors;

ii) Greater certainty as to the responsibilities and obligations of managed investments scheme operators (i.e. Responsible Entities or RE); and

iii) Reduced costs of managing schemes.

We comment on each in turn.

i) Improved Protection for investors

An RE requires a minimum capital of $5million. It is not clear how this capital adequacy standard has been set. It appears to have been set by ASIC, even though APRA is usually associated with the task of setting and monitoring minimum capital adequacy standards. Confidence in the financial stability of the Australian managed funds sector is important to secure domestic and international investor support. Investors are now more aware of the capital requirements of the financial sector following recent high profile collapses such as HIH. The change in the structure of the Australian managed funds industry under the MIA will be foreign to many offshore investors, and the combination of this different structure and recent questions over capital adequacy may deter offshore interest in Australian managed funds.

It also remains unclear as to how an RE organisation with a capital base of $5m and focused on growing its retail funds under management will offer greater scrutiny of investors' rights than in the case of a managed investment scheme, where the latter incorporates an independent third party trustee which has a capital base considerably higher than the RE and whose historic core operating activity is as a Trustee. Under the former, conflicts of interest are clear. Under the latter there exists an independent arbiter of conflicts of interest.

It is even more difficult to envisage that improved investor protection emerges from an RE organisation with a capital base of $5m and focused on growing its retail funds under management compared to a managed investment scheme which

    i) Incorporates an independent third party trustee with a capital base considerably higher than that of the RE and whose historic core operating activity is as a Trustee; and

    ii) An independent custodian, which has substantial capital reserves and a long track record as a leading asset custodian.

In summary, it seems a difficult proposition to argue in the absence of any evidence to the contrary that the single responsible entity will offer improved protection with a minimum capital of $5m compared with the traditional two-party structure. There is a clear case for offering retail investors in a master fund managed by a retail financial services company a choice of investing in a managed investment scheme issued under either a single responsible entity structure or the two-party structure where

    i) The Manager and the Trustee are not related entities; and

    ii) The Trustee maintains a capital base adequate as per the requirements of ASIC and/or APRA.

As a postscript, it is also not clear why a direct investment in any listed company (such as HIH or OneTel) is an eligible investment for investors in a master fund when an investment in a two party structure that invests on a diversified basis in listed companies is currently an ineligible investment. This anomaly strengthens the case for the refinement proposed by Constellation.

It is also worth noting that our foreign competitors have a clear advantage when it comes to Section 601FC(4). This section prohibits investment in an unregistered managed investment scheme. However the term `managed investment scheme' is defined to exclude shares in a body corporate. Overseas, companies are frequently used as managed investment vehicles. The laws of many countries facilitate the use of companies as managed investment vehicles since they permit reduction of capital by the redemption of shares. A responsible entity of an Australian registered managed investment scheme faces no prohibition or restriction on the investment of fund property in such a company.

ii) Greater Certainty of Responsibilities and Obligations

In early August 2001, ASIC released the results of its 2000/2001 surveillance of responsible entities. Their surveillance revealed breaches or compliance failures in 69 of the 83 RE's inspected. ASIC noted the following incidence of breaches:

      • Breaches of the compliance plan (53% of RE's inspected)

      • Breaches of licence condition (26%)

      • Breaches of the Corporations Law (37%)

      • Inadequate compliance and operational practices (80%).

These results are not reassuring that managed investment scheme operators have universally embraced their responsibilities and obligations under the MIA, and would cause investors to doubt that improved protection has emerged. ASIC noted that there was a lack of active implementation of compliance arrangements and a lack of strong management commitment to implementing compliance plans in some RE organisations. When one considers that most REs were previously the investment manager and have subsequently absorbed the Trustee role, the outcome is not surprising since the business focus historically of the two parties (i.e. investment manager and Trustee) was quite different.

iii) Reduced Costs

The current MIA has had the unfortunate effect of discouraging specialisation by encouraging specialist investment managers to take on the broader and more general role of single responsible entity (RE). This inhibition of specialisation reduces the potential economies of scale and thus reduces the economic efficiency of Australia's managed investment industry. Accordingly the MIA reduces potential cost savings for investors. The MIA should be constructed so as to encourage retail financial service companies to focus on certain core strengths such as retail customer management, and facilitate the growth of specialist investment managers who provide focused investment management services to their retail financial services company clients.

About Constellation

Constellation Capital Management Limited ("Constellation") was established in 1999 to provide specialist investment management services to wholesale investors, and commenced managing client funds in July 2000. The core business focus of Constellation is investment research and portfolio construction and management. Investors can access Constellation services by way of a separate investment management agreement ("IMA") or by way of an investment in a unitized pool. Constellation holds a restricted Dealers Licence issued by ASIC on 29 February 2000.

To enable Constellation to remain focused on its core areas of specialisation, other essential activities such as investment administration and custodianship are outsourced to independent third parties who are acknowledged leaders in these fields; e.g. we currently utilize Commonwealth Custodial Services, a subsidiary of Commonwealth Bank of Australia for these activities, and Perpetual Trust Services Limited is the Trustee for the Constellation Australian Equities Fund, which is designed for wholesale and professional investors including retail financial services companies. To date Constellation has chosen not to act as a single responsible entity as we wish to remain focused on our core operating activities of investment research and portfolio management and do not seek direct relationships with retail investors.

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