Cover Story: Karen McLeod
Cut through
Ethical Investment Advisers principal adviser Karen McLeod shares how the bespoke models her firm built from scratch are helping her clients make a difference. Jamie Williamson writes.

Managed accounts are arguably one of the most divisive invest­ment vehicles out there. While use has certainly increased in recent years, for every financial adviser praising their benefits, there remains many with a long list of reasons for not using them. And some of those reasons have changed in recent years, catalysed in large part by the Royal Commission exposure of the seamier side of the financial advice space and the numerous conflicts of interest that can arise when a managed account solution is implemented.

For others, the idea that they wouldn't consult a client on every portfolio decision prior to making it sets alarm bells ringing and red flags waving.

Anecdotally, I know that my clients have probably performed better than they would have had I not moved their money into ethical investments.
It's a sharp contrast to the narrative of efficiency and transparency that traditionally dominates discussions of managed accounts and, as far as Ethical Investment Advisers principal adviser Karen McLeod is concerned, it's a lazy way of thinking.

"It all comes down to how you structure it... You're still giving a lot of advice, you're still providing all of the same documentation - it's just not so onerous and focused on the transacting," she says.

"You need to be extremely careful that you aren't conflicted. We have done this by creating two sets of models and rebating all fees where possible, or only charging a very minimal fee to purely cover the platform menu charges, external research charges and time for staff to place trades and compliance."

It's an intriguing concept: a financial adviser specialising in ethical investments advocating for a solution deemed unethical or conflicted by many.

McLeod has been doing so for over 12 years now, having first seen managed account technology at an industry conference in the early noughties, instantly recognising the benefits such a vehicle could provide ethically-minded investors.

But it would be a further six years and a shift in her career before it would become a reality.

McLeod got her start in the financial advice space when she in­terned at a stockbroking firm while studying a bachelor of business, international business at university, inspiring her to also study a di­ploma of financial planning.

From there she entered what she calls "mainstream financial ad­vice", working with the likes of Godfrey Pembroke and Genesys Wealth Advisers. But after a few years, McLeod found herself be­coming uncomfortable about some of the investments her clients were holding which, in turn, made her uncomfortable in her role.

"I found myself wondering why I would be putting clients into stocks that I personally thought were harming the planet, its people and the environment," she explains.

McLeod felt that if she were personally going to make a change in the world, her occupation had to change in some way first.

She set about looking for solutions, or "clean tech options", that would help her in making a positive change to the planet and in doing so met Louise Edkins and Terry Pinnell of Ethical Investment Advisers.

Two years later, McLeod made the call to specialise solely in ethi­cal investing and transition her clients to Ethical Investment Advis­ers. That was 11 years ago, and she hasn't looked back since.

"Anecdotally, I know that my clients have probably performed better than they would have had I not moved their money into ethical investments, so that's been really rewarding," she says.

Recent insights from the likes of AXA Investment Managers and MSCI back this, with AXA finding companies with the highest ESG ratings proved more resilient during pandemic-induced volatility. At the same time MSCI compared its ESG indexes to its parent indices for Q1 2020 and found the former outperformed the latter convincingly.

"Our clients have been very well protected throughout COVID-19 because we don't have exposures to all the things that went down. We don't have exposure to retail, hospitality, airlines, we're very underweight banking and obviously have no resources exposure," McLeod explains.

"On the flip side, what we are in - like healthcare, telcos, infra­structure - have all performed really well."

McLeod says this is also due to the firm's use of separately man­aged accounts.

From the outset, the business recognised the potential for conflicts of interest or perceived conflicts of interest when building and imple­menting an in-house solution and stamping this out was important, not least of all because of its focus on being ethical.

To combat it, a separate business was established which operates as a subsidiary of the dealer group. The director of that business cannot recommend the models and the advisers themselves that are recom­mending the SMAs don't receive any incentives.

Ethical Investment Advisers made its first SMA, the Ethical Ad­visers Mid Cap SMA, available for internal use in 2014.

"We created that purely because clients that want to invest ethi­cally often find that those investments are quite small capitalisation or medium cap companies, and they didn't want to have $10,000 holding in a very small, volatile company," McLeod explains.

By using a managed account, McLeod is able to give her clients access to 40 different companies, ensuring diversification.

Before long, the business also introduced a large-cap SMA and, in November 2019, a pure fixed income model and a pure growth portfo­lio. The former offering is only available for internal use, while the lat­ter two are internal and external and the fees vary to ensure no conflict.

"Those have quite a strong positive allocation to solutions in the marketplace and also a strong negative screen which is avoiding sig­nificant harm - much stronger than any other equivalents in the mar­ket," McLeod says.

Fees are charged at 0.33% for the external growth and fixed income offerings, while fees on the external mid-cap SMA sit at 0.66% and 0.44% for the external large cap.

For full transparency, advisers and clients can access a full list of invest­ments and the underlying holdings online. There is currently about $45 million held across the suite of SMAs.

Each fund manager, its holdings and its mandate is scrutinised by Ethical Investment Advisers and its investment committee, which meets every three months and includes BetaShares' chief economist David Bassanese, to ensure suitability ahead of inclusion. Internally, advisers meet every three weeks to discuss the models.

"I suppose the advantage for advisers using our offering and their clients is that when a new fund or stock is issued, we can incorporate that into the SMAs quite quickly and, if it's superior to the existing fund or investment that's in there, they get to take advantage of that straight away without having to wait for their next review," she says.

When making those decisions, it comes down to financial performance, integrity of the manager's process and their particular mandate, McLeod says. But the most important thing is to look at their underlying holdings.

"We look at how they're voting if they're voting, and if they're not we question that. We connect with them regularly so we know if they're planning any changes to their mandate, such as extending universes to include 200 stocks as opposed to 100 - then we would look at all of those companies that have been included that weren't previously," she says.

As ESG investing has gained momentum in recent years, more products have come to market but because there is no set standard when it comes to what makes a product ethical or socially responsi­ble, the space has become heavily greenwashed.

But while most would think this makes it harder to ascertain the exact purpose of a product, McLeod says it has actually made it easier.

"There's a lot of choice in this area so we have to be quite particular in who we select, especially in the international equities space, so it's really about cutting through the rhetoric and the marketing spin," she says.

"But we've been doing this for such a long time that it's a lot easier to do that sniff test because there's a lot of people that are not authentic about what they're trying to deliver when you look at the holdings."

And the result of all that work is passed on in full to McLeod's clients; because ethical investors demand transparency, Ethical Investment Ad­visers lists in full all the investments that are in each SMA, along with all the underlying investments.

Her clients are also getting the benefit of a product that few other investors have access to.

"It seems that there is a bit of a gap in the market for a diversified solution under this structure, simply because it is a complex require­ment when you're investing ethically and it's like having two jobs re­ally - you're dealing with all the financial requirements as well as the ethical, which is a movable feast," McLeod says.

Another point that is sometimes raised as a deterrent to imple­menting a managed account solution is that they're not for every­body; it's an extra cost that only some clients, usually those with a higher balance, would be suitable for.

McLeod refutes this too, saying it's about how you use them.

Her clients range from mum and dad investors to high seven-figure balances and philanthropic organisations, and virtually every client is invested to some extent via managed accounts.

This is largely due to the low cost nature of the solution and guar­anteed diversification, and also the fact that they don't want to be too heavily involved in what's going on.

"We actually created them for our smaller clients and we've found it really beneficial for those clients that are time poor or just busy travelling, that need active management of their investments but they want it at a low cost and they also don't want to lift a finger... They want us transacting on the account without them having to respond regularly for investment changes," she says.

For sophisticated clients, such as wealthy wholesale or philan­thropic investors, McLeod takes a core satellite approach.

"In that instance, we would use our managed accounts as a core for their portfolio and then we can complement that with illiquid-like re­newable energy infrastructure investments or unusual social bonds, or some other sort of instrument that meets their ethical values but are less liquid," she explains.

To ensure the engagement is still there, Ethical Investment Advis­ers sends regular newsletters, sharing the performance of the models, educational resources and individual stock stories which, McLeod says, have really resonated with clients.

"They like understanding and feeling close to the investments that are making a difference," she says.

It's also a useful tool in communicating to clients where their money is going and demonstrating their money being put to work and the difference they're making.

Through its growth model, clients can invest in the WHEB Sus­tainable Impact Fund, distributed by Pengana. WHEB provides an impact calculator on its website where investors can input the amount they have invested in the fund via the model and find out how many mega litres of water has been treated, how many children have received an education or how many cars have been taken off the roads to reduce carbon output as a result of their investment.

"Clients can see the good their money is doing and that can be really motivating for them, but also educational at the same time," McLeod says.

Education is such a large component of an adviser's job, no matter how "low-touch" the investment solution, she adds.

McLeod recalls conversations with clients who express concerns about mining investments.

"Galaxy Resources is a lithium miner in Australia, and some cli­ents have said they don't want any mining and would prefer recy­cling, but then decided they'd be ok with it because lithium is used in battery technology," she explains.

"Others say it's okay because Galaxy is Australian-based - they don't want anything out of Africa, but Australia is fine because the way it's mined in Australia, using brine pools, is less destructive."

"It's not black or white."

But if clients do wish to remove any particular investments, a screening functionality can be used to do so and the money that would have otherwise been invested in the vetoed company can be switched to cash or distributed across the remaining holdings or a replacement holding.

"Same goes for if an investor didn't like a particular manager, we can remove the manager and put it across the remaining... but because everything we put into a client's portfolio is picked specifically for them, we don't often have to screen things out," McLeod says.

Still, for McLeod, using managed accounts has changed the way she gives advice for the better.

"It's almost more rewarding because you know the client is getting all your best ideas via that core offering so you feel that, investment-wise, they're being looked after really well," she says.

"We are constantly having meetings regarding those models and we have external consultants; the clients are very much well looked after for quite a low fee."

However, McLeod acknowledges that building an offering from scratch may not be realistic for some advice businesses. The process can be a costly and time-consuming, she says, particularly if you're attempting a niche offering in the way that Ethical Investment Advisers has and hoping to make it available externally.

It's for this reason that the two models released by the licensee last year are, quite uniquely, 100% growth and 100% fixed income.

"The other option was to create all the different asset allocations, like balanced or conservative, but we thought this would be more efficient and cost-effective for us because that way you're only paying two sets of fees to the platform to have on their menu," McLeod explains.

"That was more economical for us and therefore better for the client. Having them on a menu is probably the biggest cost to consider."

Other costs advice businesses should consider from the outset are those related to research and the running of the portfolios.

"We do a lot of our own research but we also use a lot of third-party research that we pay for. And you really need to think about how many hours of your employees' work week is going to be spent running those models. For us, we've done it very much on a tight budget," she says.

But that's not to say that costs should be a deterrent, with McLeod saying SMAs are probably ideal for smaller advice firms looking after a lot of clients with similar needs. If the advisers also have similar needs, then a managed account solution makes sense, she says.

"An added bonus that we've found is that it doesn't matter where we are, we could all very easily look after eachother's clients because they are all so similar in their needs. And every adviser in the group can use the models because we've all got clients with the same or similar values," McLeod says.

For McLeod, particularly as regulatory pressure mounts and the cost of advice rises, using managed accounts is a no brainer for advice businesses searching for scalability and sustainability. And, as the desire to invest ethically grows, so too does the need for transparency of holdings.

"Advisers really need to be thinking about how they're going to solve for that," McLeod says.

And a managed account solution might be just the ticket.

At present, there is no mandatory requirement in Australia for fund managers to disclose their portfolio holdings. Some do, but the vast majority don't in the name of commercial sensitivity.

"How can you as an adviser tell a client that they're in the wrong fund when you can't even see what they're invested in?" McLeod asks.

"If you've got an SMA, you can see exactly what's in there."

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