(see also How YourShare works with Master Trusts / Wrap Accounts)

The Australian Consumers Association Choice Magazine, published the following information about Wraps and Master Trusts on their web site www.choice.com.au.

Wraps and Master Trusts

They can provide convenience and choice, but high fees and adviser kick-backs can take a big chunk out of your returns. - Reviewed 06/06.

These days if you go to a financial planner and follow their investment advice, you'll probably soon find your money in a wrap or master trust. So dominant are these one-stop-shops for accessing a wider range of investments that they now gobble up the majority of retail investments.
These 'platforms' (basically administration structures for your investments) have taken the market by storm following heavy promotion by fund managers and advisers in recent years. But are they the best place for your money? In this report we:

• Look at the advantages of this popular way to invest
• Break down the costs
• Highlight traps you should watch out for
• Give an investment checklist and
• Give tips to help cut your fees by thousands.

How a master trust works

A master trust is an administration structure for your investments:

• It provides a central 'hub' account, is often accessible online, and gives you a single report at tax-time.
• Consumers can invest in master trusts through financial planners or sometimes direct; but you may have to pay the full entry fee if investing directly.
• The investment 'menu' includes a choice of fund managers and funds. You get a central account to invest in a diverse range of funds and managers, spreading your money around without having to go to lots of fund managers separately.

Your choices range from conservative funds that invest mainly in deposits or government bonds, to balanced, growth, property or riskier Australian and international share funds. Share trading isn't possible with 'lower end' platforms (they offer less choice and fewer features than some full-service wrap platforms).

You can switch your money around different funds as your preferences change but switching fees may apply.

Fees

Typically you'll pay:

• entry fee (up to 5% or more of your investment, but that's negotiable) and
• annual management fee depending on the investments chosen. Of that, up to about 0.6% goes to the planner as an ongoing trail commission each year. Up to 2% may be 'dialled up' by the adviser as an additional annual 'adviser service fee' (again, negotiable).

The management fee may cover the master trust's administration costs as well as fees charged by the underlying funds you choose within the master trust. With other master trusts the administration and management fees are split up.

Advantages

Here are some of the advantages of wraps and master trusts:

• All your investments are in one place. Investment platforms (such as wraps and master trusts) can combine your managed funds, other investments and even margin loans or shares into one package, which you can often access over the internet.
• Consolidated reporting. Particularly handy around tax-time - you'll get one report and statement for tax purposes and you may also receive regular reporting updates.
• Diversification and choice. You can spread your risk among different asset classes and a much wider range of fund managers than would otherwise be possible for most investors.
• Wholesale funds. Some 'boutique' and wholesale fund managers aren't available to retail investors and can require starting amounts of anywhere from $500,000 to $100 million. Wraps and master trusts can pool your money with thousands of other small investors to access these wholesale funds, which generally have lower management fees than retail funds.
• Tax rebates could also be worth investigating; fees may be tax deductible with certain platforms.

Watch out for the traps

Choosing the wrong one. There's a platform for almost everyone now, including smaller investors. Making your choice based on short-term needs may be ill advised - a master trust geared to small amounts may be suitable now but what about in a few years when your investment has (hopefully) grown? If you decide to switch to another more suitable master trust you might end up with a pretty hefty Capital Gains Tax bill when leaving the old one. This doesn't apply to wraps, which allow you to transfer in and out without triggering a capital gain or loss.

The way they're sold. Some platforms are only available through financial planners, who often receive higher trail commissions than for recommending ordinary managed funds (see What are the fees? for more).
What choice? Some financial planning houses recommend just one platform provider. Ask your planner how many platforms they recommend and the reasons for those recommendations (find out about fees, commissions and if there's any mark-up to wholesale fund fees).

Conflicts of interest: 'Over-ride' commissions are sometimes paid by platform providers to financial planning groups for the big number of investors they bring into the platform. This could cause a conflict of interest - has the adviser's commission or 'over-ride' payment been put above your best interests?

Is it 'open access'? An in-house fund may be operated by your financial planner and open only to the clients of their business. If you want to change adviser, you may have to leave the fund, possibly involving exit fees and Capital Gains Tax. Open access funds let you change adviser without leaving the fund.

Complexity - you'll probably need to use a spreadsheet to compare fees for different platforms. All costs are set out in Product Disclosure Statements, but understanding and comparing the myriad fees and other details in brochures running to more than 50 pages can be very difficult.

Limited choice of funds. The fund manager marketing the platform may not include all available funds on its investment menu.
What choice and features do you need? Some platforms offer hundreds of investment choices but there's no point paying for options you won't use. One fund manager told us that around 80% of investors in some 'full-service' platforms have money in just 20% of the available funds.

'Nil entry fee' options can be more expensive - if it means you'll pay higher ongoing and/or exit fees instead (that may also be true for ordinary managed funds).

Platforms pushing their own products. The wrap or master trust provider may include many of its own managed funds. For example, ING's OneAnswer includes various ING investment funds while Colonial First State's FirstChoice includes around Colonial funds, among others. Furthermore, some platform providers charge more for other companies' funds within their master trust or wrap.

What are the fees?

The main reasons to invest in a wrap or master trust are consolidated reporting, choice of investments and access to 'wholesale' managed funds. But these features may come at a price. Investing through platforms can be more expensive than 'single manager' retail funds.

Here are some typical fees and commissions (this article looks at non-super investments and some of these fees also apply to ordinary managed funds):

• Entry or contribution fees: up to 5% (but likely to be less) of your initial and subsequent investments may be immediately swallowed up in entry fees that go to the adviser. However there's room to negotiate. You can't always bypass the adviser and go direct to the platform to avoid entry fees - wraps and master trusts are often designed to keep planners in the loop. If you don't need advice or you're prepared to pay for it separately, discount brokers are an option;
• Trail commissions around 0.5% to 1% of your investment may be paid annually by the company to your financial planner - even if you don't ask for further advice;
• Adviser service fees: a more recent invention ranging from nil to 2% of your investment each year. They're negotiated with your adviser and may be debited from your account each month. Can be in addition to other ongoing fees;
• Administration fees: charged by the wrap or master trust to administer your account. This is sometimes known as the account fee, which may or may not include some of the other fees we describe;
• Fund management fees: what you pay underlying investment funds to manage and invest your money (this may or not be bundled with the platform administration fee or ongoing fee). Typically wholesale funds available through wraps and master trusts have annual fees of around 0.5-1%, usually lower than what retail managed funds cost; and
• Other fees include costs to switch between investment funds and transaction costs (for example, to buy shares), which are sometimes included in the platform's administration fee. Switches are usually 'free' but the difference between the buy and sell price is the cost of the transaction.

Doing the sums

In some platforms, ongoing annual costs can be over 2.3% of your investment each year, depending on the product and funds chosen. If you add the adviser service fee, costs can exceed 4%. You may get access to cheaper wholesale funds but look at the overall costs, advice and the features you're paying for.

Ordinary managed funds generally cost around 1.5% to 2% each year (including the management fee and adviser trail), less than the overall costs of some platforms. Investment fees can have a big impact on your long-term returns, especially when share prices decline. When the market performs poorly high fund management fees really hammer you. In the last three years the Australian share market has had a very good run - fees don't seem as important to investors when the market is going well. But when markets go down, people really focus on the costs and their impact. Remember, if you're paying 2-3% each year, that's what your funds need to return for you just to break even. Initial 'getting-in' costs, adviser fees, and trying to keep ahead of inflation can make the investment hill even steeper to climb.

How do they perform?

The returns you'll receive from wraps and master trusts depend on the funds chosen from the investment menu, tax, fees and other factors like how quickly your transaction instructions are carried out. Before choosing a platform, it's a good idea to decide on the type of funds you're interested in. Compare their track record, read up on features and consider getting expert financial advice. Compare returns net of tax and fees to get a realistic picture.

One thing we know for sure is that high fees will take a significant chunk out of your investment returns. According to one discount broker if you invest $50,000, paying a 4% entry fee and annual fees that are just 1% higher per annum than an investor with the same portfolio who has their entry fees rebated, after 10 years you'll be almost $18,700 poorer than the second investor who avoids the entry fee and higher annual fees. The flipside is that because investing can be complicated and risky, many people need professional advice. This advice may be commission- or fee-based, but either way you'll need to factor the cost into your decision.

Checklist for investing

• Your situation: how much have you got to invest? Entry amounts vary, but $50,000-$100,000 is recommended as the minimum starting amount to effectively invest in some portfolio platforms. Some platforms penalise small amounts through transaction and annual fees, while others have lower minimums and are suitable for investors with smaller amounts.
• Features: what choice of funds do you need? Will a cheaper managed fund suffice, or do you need the service and choice a portfolio platform provides? Do you want to trade shares or move money between funds? Do you need extra features such as insurance or margin loans?
• Costs: how will you pay for advice - commission- or fee-based? Have you compared platform, fund manager and adviser costs to find the best value for your needs?
• Service: how quickly are reports generated and transactions, such as switches between managed funds, carried out? Some platforms can execute your transaction orders on the same day; with others it can take weeks.
• Tax: What tax will you pay? Have you confidence in the company running the platform? Some commentators predict the market will consolidate in the next few years, meaning there'll be fewer wrap and master trust providers and some may be wound up or taken over. If this happens, you may need to switch to another platform and this could trigger a big Capital Gains Tax liability. This depends on the type of platform.
• Advice: consider getting professional tax and financial advice for this often complicated area. It's recommended that you do regular reviews (annually) to make sure your investment strategy remains aligned with your needs.

How to save thousands in fees

Don't pay the full entry fee. It can be as high as 5% or more of what you invest and can go to the financial planner or adviser. But this is negotiable. Wrap and master trust application forms often include a box advisers can tick to rebate the entry fee. Ask them about it or compare what different advisers will charge you.

Keep bargaining. Trail commissions and 'adviser service fees' can sometimes be rebated or 'dialled down' by advisers.

If you already know the platform you want consider using a discount broker - they'll often refund the full up-front commission and sometimes part of their trail.

If you don't require advice (or you're prepared to pay for fee-for-service advice separately) and you're interested in investing direct, it's worth comparing discount brokers' fees and services.

Jargon buster

Baby wraps: the first platforms were designed for investors with hundreds of thousands of dollars, with some providing up to 600 investment options. They weren't appropriate for smaller investors - 'baby wraps' were born to fill this gap. They're also sometimes known as 'lite' platforms and 'mini-master trusts'.

Investor Directed Portfolio Service (IDPS): the regulator's official term to describe master trusts and wrap accounts.
Master trust: an investment vehicle enabling individual investors or super funds to invest in one or more underlying investments, usually wholesale managed funds. They allow access to a selection of fund managers (either chosen by you from the master trust's list, or chosen by the master trust manager). Assets are held on behalf of the client. The trustee is the legal owner.

Portfolio platforms: a generic name for wraps and master trusts.

Wrap accounts: similar to master trusts, except you get ownership of all the investments you make, which are 'wrapped' up in one administration system. As with master trusts, your accounting, reporting and tax are taken care of; you'll get a single consolidated report at tax year-end. Assets are held in the client's name as the legal and beneficial owner (may differ for super).

Case study

David, who has been investing in shares for around 10 years, and is keen to diversify, looked into wraps and master trusts recently.

"Their great appeal for me was the ability to access wholesale managed funds with their nil entry fees and reduced management expense ratios (MERs)," David explains. "But after some investigation I discovered some of the better performing wholesale funds allow investments of as little as $10,000 to $25,000. I know this isn't 'small', but it's a lot less than the $500,000 I thought was required and negates my primary reason for considering a master trust," he says.

David was surprised by some of the administration costs he encountered. He says platform MERs can look OK but account and other fees need to be added to find the real cost. It may be better value to go direct to a wholesale fund. With other funds and platforms the opposite can be true - sometimes the cheapest way to invest in a fund is through a wrap or master trust (in the case of some wholesale funds, it's the only way).

David thinks master trusts are a great way for investors to create a balanced managed portfolio, especially if they want to use a regular gearing (borrowing) facility and have the ability to move money around (for example from international shares to bonds). But he eventually decided that directly investing in managed share funds through a discount broker (which rebated the up-front commission) better suited his needs.

This article last reviewed June 2006

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For more information on superannuation please also refer to the Australian Tax Office site or Fido, the consumer website of the Australian Securities and Investment Commissions (ASIC), under Superannuation.

Disclaimer
The information in this document reflects YourShare Financial Services Pty Ltd ('YourShare') understanding of existing legislation, proposed legislation, rulings etc as at the date of issue. In some cases the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances. The information given in this document is of a general nature and has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision a prospective investor needs to consider, with or without the assistance of a professional adviser whether the advice is appropriate in the light of their particular investment needs, objectives and financial circumstances.