This article appeared in the Sydney Morning Herald on 18th December 2013, written by Michael West.
Imagine if the fund manager was BT and its only investment was a bunch of shares in Westpac, which is BT’s parent.
Or imagine it was MLC, with its only assets being shares in National Australia Bank; or Colonial only invested in Commonwealth Bank stock, or ANZ with a holding in ANZ shares and nothing more.
It might sound far fetched but this is precisely what is going on in another asset class. That asset class is cash.
An investigation by Business Day has found the big four banks are using their cash management operations as a source of cheap funding.
So their wealth management customers are being dudded, because the organisations holding their money are settling for lower returns by investing only with their parent companies, rather than seeking best return out in market.
Duty to diversify
Just as in bonds and equity funds, cash funds have a duty to diversify – in case of disaster. The fund manager also has a duty under the law to pursue the best return possible by shopping around in the bank bill and CD (certificate of deposit) markets.
Instead, the investment giants BT, ANZ Cash Management, Colonial and MLC are all funneling their clients’ money straight upstream into their parent banks.
“Westpac and St George is where the cash is held and it’s a mix of deposit and bank bills,” a spokesman for BT confirmed.
A spokeswoman for Commonwealth Bank also confirmed that cash management clients of its Colonial investment operation were invested with the parent bank.
“I can confirm this is held in cash deposits,” she said.
The numbers are enormous. Colonial’s FirstChoice investment platform is called FirstRate Saver. FirstRate Saver accounts for about 5 per cent of the overall $63 billion in funds under management on the FirstChoice platform. So the FirstRate Saver manages $3.3 billion.
Its rate is now 2.4 per cent – well shy of the 3.3 per cent rate on a four month term deposit with the Commonwealth Bank, or for that matter the 3.7 per cent rate on offer with rival UBank to park money for three months.
Although the banks are clustered around the 2.4 per cent return mark for their cash fund customers, ME Bank is touting 3.5 per cent for just one month. RaboDirect is at 3.35 per cent.
What we don’t know is whether any of the responsible entities for the big four wealth managers bothered to contemplate enhancing the returns for their customers by parking any money with ME Bank or Rabobank. It is highly unlikely.
Had they done this, however, their customers might have been considerably per cent better off.
Safe Asset
Cash is considered the safest asset class thanks to its liquidity but it is also the lowest yielding. As in property, bonds or equities, the fund manager is not only beholden to diversify but also to chase the best possible return for the client.
Sadly, this is not happening in the cash market. The wealth divisions of the big banks are merely investing in their own parents, giving the big banks a cheap source of funding at the expense of their millions of customers.
Spokespeople for MLC and ANZ’s wealth management arm also confirmed their customers’ cash was being funneled up to the parent banks.
One high net worth client of MLC subsidiary Plum Financial Services said he noticed MLC had allocated a few hundred thousand dollars of his investment to the MLC Cash Fund earlier this year owing to the volatility of the sharemarket.
“On reviewing the performance of this fund [trackable month by month on the MLC website] I was surprised to find that it was so low [year to date about 2.5 per cent net]. This is miserably low even in today’s interest rate environment, where three- to 12-month term rates are still available around the 3.5 per cent to 4 per cent mark, and my online deposit with NAB is currently paying 4 per cent. Of course, if we go back a year or so available rates were significantly higher,” he said.
“The performance rates are net of tax [maximum 15 per cent] and fees, but as far as I can see there is an unexplained gap of around 1 per cent between what I would expect the fund quite easily to have achieved, and its actual performance.”
According to the PDS: “The fund invests in a range of short-term securities issued by Australian government bodies, banks and corporate borrowers. MLC currently utilises the expertise of National Specialist Investment Management in the management of this fund. The portfolio is designed to suit an investor where a high level of capital security is paramount.”
It appears that MLC’s investment advisers are placing their clients’ superannuation in the MLC Cash Fund, which then invests exclusively with MLC’s parent company, NAB, at below market rates, for which service MLC charges 34 basis points.
There is undoubtedly a conflict of interest in the wealth managers placing funds exclusively with their parents. But it may be more than a mere lurk.
The ANZ spokesman pointed out – and this may be the case with the other banks also – that the investment with the parent bank is disclosed in the Product Disclosure Statement.
Notwithstanding any disclosures buried in the PDS, though, the responsible entity (RE) – which has the dual role of trustee and manager of an investment scheme – is required to put the interests of members (investors) ahead of the interests of the bank.
It seems clear that this is not the case. Rather than chasing 3.4 per cent yields for their members, the banks are parking it with themselves at far lower rates, rates in the vicinity of 2.4 per cent.
Section 601FD of the Corporations Act says “an officer of the responsible entity of a registered scheme must (a) act honestly; and (c) act in the best interests of the members and, if there is a conflict between the members’ interests and the interests of the responsible entity, give priority to the members’ interests . . .”
In their defence, the banks may contend that they need to have the cash available at the shortest notice for the purposes of investor security – hence the low rates.
Yet there is little sense in running a billion-dollar fund on the basis that everyone might want their cash back tomorrow. What you would do is use the incoming daily cash to pay out the daily withdrawals to save on transaction costs, and you would also make assumptions based on actuarial advice as to the varying maturities of the deposits that you make, spreading the risk of course as is required while remaining invested short-term.
Non-Bank Players
Non-bank players in the cash market, such as The Trust Company, typically shop around, diversifying their customers’ cash between the banks, chasing the best rates in their members’ interests.
That is what fund managers are paid big bucks to do, invest competitively in order to enhance returns, and diversify for purposes of safety. As the NAB customer says, they are not paid to clip the ticket for 36 basis points.
A cynic might say that, as the banks are underpinned by government these days, they don’t have to worry about safety, so why diversify? If they don’t have to worry about safety, though, that is all the more reason to pay a higher return. Unfortunately, competition has been lost in banking and wealth management due to the encroaching concentration of vertically integrated big players who control the market.
On rough numbers there is $510 billion invested in master funds in Australia. Some $19 billion is parked in cash and another $5 billion in capital guaranteed. But there is also $245 billion of the $510 billion in “mixed portfolios”. Perhaps 8 per cent of that is in cash too. These figures don’t count self-managed super.
It may be that the nation’s investors – which is most of us via a portion of superannuation – are being short-changed to the tune of hundreds of millions of dollars a year thanks to interest forgone on what might have been much better cash rates. If so, and given the competitive dynamics of the banking industry, this cash cartel is more of a racket than a lurk.