Reporting

Q – How often does the Agentia Customised Portfolio Service provide online information and reporting to clients?

Investors can view the performance and value of their portfolio on a daily basis. These reports include dividends and franking credits as they are received, purchases and sales, and any associated brokerage costs.

The reports are available on line at any time.

Q – What are some of the key reports that are available in the Agentia SMA?

Some of the key reports include

• Portfolio Valuation Report – This report provides a full valuation of your portfolio and can include a breakdown of the portfolio by asset class.

• Portfolio Performance Report – This report gives you the performance of your portfolio over a selected date range.

• Transaction Reports – This report lists all the buys and sells in your portfolio. Details include brokerage costs as well as all other fees and charges deducted from your account plus a full transaction history.

• Income and Expense Reports – This report lists all portfolio income and expenses and includes franking credits.

• Tax Reports – Daily tax reporting is available online with a tax parcel level interface to many commonly used accounting software packages.

Transaction Netting

Q – What is transaction netting and how does it work?

1. At the end of each trading day the system program checks investment holdings in all accounts against the latest update from each model portfolio investment manager and against any portfolio customisations set by the investor and then against actual investment holdings.

2. The program will then determine what changes will need to be made to update all portfolios and then determine the most efficient way to make those changes. This is what we refer to as netting and it can be done very efficiently because all investments in all portfolios are held under a single custodial HIN.

3. Only the differences that remain after netting will result in on market trades. Since it is trades that attract brokerage fees, by minimising trades we can pass on real cost savings to investors.

Example – An investor may invest in a number of different investment models in the Agentia Customised Portfolio Service, however they will see their portfolio in their account as if it were a single portfolio. In this example the investor has placed their funds in three (3) different Australian share models and each manager holds some BHP shares in their portfolio. When the investor checks their portfolio online they will see that they hold 1,350 BHP shares. The shares are actually spread across the 3 fund/model managers as follows:

• Model Manager A holds 500 BHP shares
• Model Manager B holds 50 BHP shares
• Model Manager C holds 800 BHP shares.

During the course of the business trading day the model managers have traded their portfolios and at the close of business notified us of their new portfolio holdings and weightings. Model Managers A, B and C have made the following changes to their BHP holding in their respective portfolios:

• Model Manager A held 500 BHP shares but elected to sell 10% of their BHP stock or 50 shares reducing their holding to 450 BHP shares.
• Model Manager B continues to hold 50 BHP shares
• Model Manager C held 800 BHP shares and elected to purchase another 5% or 40 shares increasing their holding to 840 BHP shares

If we look at the investors overall holdings in BHP they have reduced by 10 shares from 1,350 BHP shares to 1,340 BHP shares. Therefore, after the computer system has netted out the trades only 10 shares will need to be traded.

So which parcel will be sold?

The program will seek out the best parcel of 10 BHP shares across all 3 models to reduce the capital gains tax (CGT) liability. For example, if one of the BHP share parcels that made up the overall BHP holding of 1,350 shares was in a capital loss position, then ten (10) shares from that parcel would be sold to eliminate CGT.

Result – The investor will see that their portfolio of BHP shares has reduced by just 10 shares. The program has reduced the number of trades across all three models and this results in fewer transactions so brokerage costs will be lower. The reduction in transactions will also reduce potential CGT liabilities.

Tax Benefits

Q – What are the potential tax benefits of using an SMA?

The Agentia Customised Portfolio Service will provide transaction options that can minimise Capital Gains Tax (CGT) liabilities in certain situations. With traditional unitised managed funds, new investors inherit the existing tax position of the Fund when they purchase their investment. This occurs because the investor buys units from a pool of units that represents their share of the value of the underlying assets of the Fund at the time of purchase. The investor just owns the units and not the underlying assets of the Fund.

This is not the case with the Agentia Customised Portfolio Service because the investor is the beneficial owner of the listed securities or assets that make up their portfolio.

There are basically 3 major tax advantages of the SMA investment structure which are:

• No embedded CGT liabilities for the investor when they purchase their investment.
• Minimised CGT trigger events will improve overall performance.
• When CGT liabilities do arise the system will choose the most favourable tax parcel(s) of securities to sell

Q – Will an in specie transfer attract Capital Gains Tax (CGT) liability?

No, there is no change of ownership and therefore no CGT event when an investor elects to transfer shares into or out of the Agentia Customised Portfolio Service. Please note, this assumes that the investor has transferred out the securities into their own name.

When shares are transferred in from an investor they will form part of the model portfolios selected by the investor. Depending on the position of the model portfolios at the time of transfer, a portion of the shares that were transferred in may need to be sold and CGT liabilities may be incurred as a result. But CGT can be managed as follows:

• Model Portfolios can be selected that most mirror the investor’s current portfolio.
• Share parcels with high levels of CGT liability can also be placed into a holding lock to ensure that part of the portfolio is not automatically sold down.
• The holding lock can be managed/varied to reduce CGT liabilities over time.

Ownership/Structure

Q – Who is the legal owner of the underlying investments in the Agentia SMA?

The legal interest is held by Praemium as Custodian, but they are held beneficially for the investor. Each investor’s cash and portfolio of securities are segregated into a separate account and held separately in trust. Praemium hold the assets under one HIN and this enables them to nett off trades and bring advantages to investors that they otherwise wouldn’t be able to get as individual investors.

Portfolio Rebalancing

Q- Will my investment portfolio be rebalanced?

Yes rebalancing occurs daily when your portfolio no longer matches the Model Portfolio(s) you have selected. The following are some examples of circumstances that may result in a rebalancing event:
1. A new deposit is made into your account.
2. The Model Portfolio Manager changes weightings within the Model Portfolio outside of the tolerance levels established.
3. The cash balance has moved below the required 2% threshold.

Fees

Q – What Fees are paid to the Responsibility Entity (Praemium)?

An Administration Fee which is the fee for operating Agentia. The fees are tiered as follows:

$ Amount Invested % rate charged
the First $250,000 0.37%
$250,001 – $500,000 0.25%
$500,001– $1,000,000 0.15%
$1,000,001 – $2,000,000 0.10%
More than $2,000,000 0.05%

The Administration Fee is calculated monthly in arrears based on the daily value of the client’s account and is deducted directly from their account.

Q – What are performance fees and how often are they calculated?

Some model managers charge a performance fee and if they do it will be clearly stated in the Product Disclosure Statement.

The performance fee is only paid to a model manager if their portfolio adds value over a benchmark. The benchmark may be an index, an amount in excess of an index, zero or a specified return (for example 2% over the RBA Cash Rate). The value added for each model portfolio is calculated for each account on each day of the performance period.

Q- How many methods of performance fee calculation are there?

There are 3 as follows:
1. Value added over an index
2. Value added over an amount in excess of an index
3. Performance must be greater than zero

Q- Is it possible that a performance fee can be paid even if the portfolio is in a loss situation?

Yes methods 1 and 2 make it possible for a manager to receive a performance fee even if the model portfolio performance is negative.

Q – What is the difference in the performance fee calculation method 3 (Performance must be greater than zero) in comparison to methods ‘Value added over an index’ and ‘Value added over an amount in excess of an index’?

The Model Manager will only qualify for a performance fee payment where the return of the Model, after payment of performance fees, is positive. Where the return of the Model is negative, the performance fee otherwise payable is carried forward until the model portfolio reaches a positive outcome.

Performance Fees Rationale – Most active fund managers receive payments between 0.5% and 1.0% per annum to administer a fund. They receive this payment irrespective of whether they add any value to the portfolio over and above their relevant benchmark index.

If a model manager elects to receive a performance fee based on ‘value added over an index’ then they will receive a percentage of their outperformance as a performance fee.

Example – value added over an index – compare 2 Fund Managers, both use the ASX 200 as their benchmark.

The ASX 200 benchmark performance is -15% for the year.

Fund A receives an annual fee 0.75% irrespective of performance and has performed in line with the benchmark -15% per annum. (Original investment – $100,000 portfolio is now worth $84,250 after fees.)

Fund B receives no annual fee but may qualify for a performance fee of 25% of any out performance over the benchmark. Fund B has outperformed the benchmark by 4% (performance of -11%). Fund B will qualify for a performance fee of 1% or $1,000 for the period. (Original investment – $100,000 portfolio is now worth $88,000 after fees.)

Continued outperformance of 4% per annum is extremely unlikely but if it continued you would not be that unhappy with the result.

Q – Do switching or withdrawal fees apply in the Agentia Customised Portfolio Service?

No, there are no switching, withdrawal or termination fees payable.

Q – Brokerage – Do you add any cost on top of your brokerage charges?

No there is no additional fee paid to anyone. Brokerage rates on all transactions are charged at a maximum rate of 0.055% including GST. For example, if your portfolio turned over $100,000 worth of securities in a year and all trades were completed on market then the total cost of your brokerage would be $55.

Q – What do the model portfolio managers get paid?

Each model portfolio manager receives an investment fee and some also charge a performance fee. If they receive an investment fee it will be calculated monthly in arrears based on the daily value of the client’s account and model portfolios selected. It is deducted directly from the client’s account and will be reflected in their online cash book which can be viewed in their account 24/7. Please refer to the Product Disclosure Statement for specific fee details.

Exchange Traded Funds (ETFS)

Q – What will I pay if I purchase an ETF through the Agentia SMA?

There are no direct holding costs for provision of these ETFs through the Agentia SMA. There will be brokerage costs associated with the purchase and sale of any ETF units on the ASX at the time of the trade. There will also likely be a small buy/sell or bid/ask spread when the ETF units are traded on the ASX.

I thought ETFs were unit trusts and that an ongoing management fee applied? Why do you say there are no fees?

A management fee does apply to ETFs as with any other managed fund. This is a fee charged by the fund issuer however, all management fees and costs are built into the ETF’s trading price; they are not a separate deduction such as the deductions you are used to seeing in an unlisted managed fund.

The investment management fee is reflected in the unit price because the internal/holding costs of running the fund are deducted to establish the net asset value of the fund which is then divided by the number of units on issue.

Netasset

If you buy an ETF with a persistent 0.2 percent discount to Net Asset Value (NAV) that reflects the holding costs of the ETF and sell it at a later date at the same 0.2 percent discount to NAV, then it was neither a cost nor a gain.

Examining the range and averages of the discounts and premiums of an ETF is the best way to examine any potential long term costs. The most highly traded and liquid ETFs are most likely to track a consistent NAV.

Q – What is the buy/sell or bid/ask price spread and will it vary?

It is the amount by which the ‘ask’ or the ‘sell’ price exceeds the ‘bid’ or the ‘buy’ price. This is essentially the difference in price between the highest price that a buyer is willing to pay for a security and the lowest price for which a seller is willing to sell it. Generally, the higher volume ETFs have the most liquidity and therefore lower buy/sell spreads.

ETF liquidity is also supported by a market maker and it is their role to satisfy supply and demand for ETF securities. The Market Maker helps tighten buy/sell spreads across the ETF market.

Q – How do ETF costs compare with direct shares and managed funds?

ETFs are generally a low cost investment, and substantially lower in cost than investing in the same exposure of individually purchased shares that represent the ETF’s index. Because the ETFs are managed using an index approach, the cost to manage the ETF is generally significantly less than actively managed funds.

Q – Why should I consider an ETF when I can just purchase an actively managed investment, won’t that give me a better result?

Not necessarily. According to the latest SPIVA (S&P Index Verses Active) Report, most active managers in some asset classes find it difficult to consistently outperform an index. The table below is an extract from the SPIVA report for the five year period ending December 2013.

Percentage of Funds Outperformed by the Index

Fund Category Comparison Index One-Year (%) Three-Year (%) Five-Year (%)
Australian Equity General S&P/ASX 200 Accumulation Index 32.21 62.83 69.67
Australian Equity Small-Cap S&P/ASX Small Ordinaries Index 5.41 10.58 17.12
International Equity General S&P Developed Ex-Australia LargeMidCap Index 77.63 84.31 75.69
Australian Bonds S&P/ASX Australian Fixed Interest Index 44.62 83.64 54.55
Australian Equity A-REIT S&P/ASX 200 A-REIT 59.60 73.68 59.05

The report also confirms that just because a manager beats an index for a period it does not mean that they will continue to beat the index over the longer term.

According to SPIVA active managers also cost on average 10 times more than an index fund.

Q – Are there any other reasons why I should consider using ETFs instead of managed funds in my portfolio?

Yes, ETFs that track an index will typically have much lower portfolio turnover than an actively managed fund. This is because securities are usually only bought and sold when the composition of the relevant index changes. In comparison, an actively managed portfolio may turn over anything from 20% to 200% of the portfolio during a financial year. Added portfolio turnover equals added transaction costs which are passed onto the investor. More turnover also increases the likelihood of incurring CGT liabilities. We call this the CGT effect.

Unlike unlisted managed funds, when ETF investors sell their units, there is no sell down of the underlying securities that make up the ETF index in order to raise the cash to pay the redemption. The ETF is simply sold on market (ASX) and the proceeds are paid to the investor who sold the ETF security.

In a managed fund one investors sell decision can impact another investor’s CGT liability because underlying assets have to be sold to get the cash required to meet the unit redemption request. This trade may create a capital gain for the managed fund and as a result all unit holders of the managed fund will be liable for a portion of that CGT liability even if they have not made a capital gain themselves.

Physical ETFs that track an index are typically highly liquid, tax efficient and low cost in comparison to an actively managed fund.

Q – What is the CGT effect?

This is the hidden cost of active management. Portfolio Managers trade to generate profit to pass onto the investor. They generally aim to beat an index and portfolio performance is also generally compared to that index before tax.

So if the fund manager completes successful trades then they will generate realised capital gains. Some or all of these realised capital gains may be eligible for CGT discounts depending on how long the securities were held by the Fund Manager. In a managed fund these realised capital gains must be distributed each financial year to the unit holder who, depending on their personal situation, may be liable for capital gains tax as a result. In order to pay out these realised capital gains, the fund manager must convert part of the underlying investment portfolio to cash. Once the distribution is paid the unit price of the managed fund will reduce to reflect the reduction in the value of the underlying assets that were used to pay the distribution.

In comparison, an index ETF does not have high turnover so realised capital gains are lower. More capital, which is actually intended to be invested for the long term, is being retained in the investment. As the index rises the price of the ETF unit rises along with the index. The lower turnover equals fewer transactions and less realised capital gains and therefore potentially lower CGT liabilities.

So in summary in an actively managed fund, much of the capital gain is typically paid along the investment journey and the unit price of the managed fund may not rise as much as the comparable index ETF. By comparison, if an investor holds an index ETF the majority of the CGT liability will typically come when they sell the ETF, assuming they make a profit.

The only way to compare the managed fund to its equivalent index ETF is to look at the managed fund unit price over a long period of at least 3 to 5 years or more, and then look at the unit price of the ETF that represents the index upon which the managed fund performance is compared. You will also need to compare the distributions from the managed fund to the distributions from the ETF to have a valid comparison. However, the final consideration in the CGT effect will be dependent on the individual circumstances of each investor. An investor who has a high marginal tax rate is likely to feel the effect much more than an investor on a low marginal tax rate.

Q – What are the risks associated with ETFs?

All investments involve risk. The main risks are that

• the value of your ETF will fall as the market falls (market risk)
• fluctuations in the value of the dollar affect the value of ETFs that invest in international assets (currency risk)
• you may not be able to sell your ETFs for a fair price (liquidity risk)

Let’s take a closer look at the risks.

Liquidity risk will vary between different ETFs. Some are very actively traded and therefore have high levels of liquidity. Others have relatively low turnover which can make buying and selling at a fair price more difficult. However, ETFs do have an extra level of liquidity in that you also trade with a market maker.

Currency risk – A rise in the value of the Australian dollar against the currency of the country or countries in which the ETF assets are held can lead to a fall in the value of your ETF. Similarly a fall in the value of the Australian dollar can have the opposite effect and increase the value of your ETF.

Market risk – A physical ETF will comprise a basket of securities that will protect you against specific risk of an individual security performing poorly. However the ETF will continue to be exposed to movements in the underlying market and its value will rise and fall with the value of the underlying market index.

Q – Who or what are ETF Market Participants?

There are two ETF markets with participants, the Primary Market and the Secondary Market.

Primary Market – This market has three (3) participants as follows:

• The Issuer of the ETF
• Authorised Participants
• Market makers

It is possible for a Market Maker to also be an Authorised Participant.

Secondary Market – This market is made up of buyers and sellers of ETF securities who trade on the ASX AQUA platform. Because ETF Issuers create products that trade on the ASX they are subject to ASX market supervision.

Q – Who are the Issuer’s?

Issuers include but are not limited to iShares, State Street, Vanguard, Russell Investments, etc.

The ETF Issuer publishes a basket of securities for delivery each trading day to the Authorised Participant who swaps the basket of securities for the ETF units when these are delivered.

Q – Who are the Authorised Participants (AP)?

These entities are authorised by the ASX under an agreement to create and redeem units in an ETF.

The AP will apply to the ETF issuer for wholesale lots of units which are called creation units (typically in lots of 20,000 units or more). The AP delivers a basket of securities in settlement to the issuer in exchange for the ETF units. On settlement, the AP then has an inventory of ETF securities that can be sold on the ASX (the “secondary trading market”). The redemption process works in the opposite way. The AP applies to redeem securities in multiples of creation units and in return receives a basket of securities.

Q – What is an ETF Market Maker?

Market makers are professional traders who provide liquidity to the market by quoting buy and sell prices throughout the trading day. They seek to maintain continuous liquidity.

Every morning the ETF Issuer distributes the current ETF‘s composition to the market which allows the market maker to price the ETF units based on the basket of underlying securities. The market makers then place a buy sell spread around the true value of the ETF units and send these prices to the ASX as orders. The orders are published in the market to trade.

The ETF creation process basically looks like this:

etfs
Q – How many different types of ETFs are there?

ETFs can broadly be categorised as either physically-backed or synthetic.

Physically-backed ETFs hold the physical assets that the ETF is designed to track. They use either physical replication, or representative sampling. On creation of units in a physically-backed ETF, an authorised participant (AP) must provide the issuer with a basket of the underlying assets. The fund retains title to those assets. In the physical replication approach, the basket of assets exactly matches the composition of the index being tracked. For example, if the ETF tracks the S&P/ASX 200 index, the basket of stocks would consist of all 200 securities in the index in the same proportion as they are represented in the index.

This approach is most common for share index ETFs.

Representative sampling – If some of the assets in an index are illiquid it may be more cost effective to use this approach at least in part to replicate the index.

In a representative sampling approach, the fund holds assets in the index it is tracking, however it may not hold all the assets in the index, or not in the same proportion as the index. The assets are selected to achieve a similar outcome to physical replication. Derivatives may also be used in limited circumstances for reasons of speed and cost.

Synthetic ETFs use a derivative known as a ‘swap’ to achieve their investment goal. They typically invest in a portfolio of securities, and also enter into a swap agreement to optimise the tracking of the index. The synthetic structure is also referred to as ‘swap replication’.

Q – How does the Swap agreement work for Synthetic ETFs?

Under the swap agreement, the counterparty must make a payment to the fund if the portfolio underperforms the index. Conversely, the fund must make a payment to the counterparty if the portfolio outperforms the index. This calculation is performed daily by the fund’s administrator and is settled regularly between the fund and the counterparty. The net effect is that the returns from the portfolio and the payment to or from the counterparty together replicate the performance of the index.

Q – Why do some ETFs choose to operate using a synthetic structure?

There are three main reasons that ETFs use synthetic structures.

1. The swap replication approach tends to minimise any divergence between the return from the ETF and the performance of the underlying index.
2. A synthetic structure may require far fewer transaction and be more cost effective as a result.
3. They can provide easier access to difficult markets. For example physically holding commodities is not practical.

Q – What are the risks associated with Synthetic ETFs.

As well as the risks common to all ETFs, synthetic ETFs involve the additional risk that the counterparty to the swap will not meet its obligations to the fund by defaulting. In the event of a default the ETF Issuer has full recourse to the physical assets which are held by the custodian however, the Net Asset Value of the ETF would fall by the amount owed from the counterparty.

Q – How can I tell if an ETF is synthetic?

If the ETF is traded on the ASX, you can tell from its name if it is a synthetic ETF. The name of a synthetic ETF must include the word ‘(synthetic)’.