Thinking about investing in an Australian Managed Fund? Know the nature of what you are investing in
Investing in Australian managed funds is a popular investment pathway particularly for investors that might not have the time or expertise to manage their own investments here in Australia.
Inherent in the nature of a managed fund is that the investors do not have day-to-day control in relation to the operation of the investment with this power being entrusted to a professional trustee or fund manager who is tasked with overseeing the investment on behalf of the investors as a fiduciary (that is, owing a duty to act in the best interests of investors, to not be in conflict and not to profit).
We are frequently called upon to act for investors thinking of investing in Australian managed funds and from years of experience in this area, there are often a number of misconceptions about the nature of the financial product they are investing in. In this article, we aim to highlight what these are together with some themes on what you should be thinking about before undertaking an investment in an Australian managed fund.
The importance of fund documents: Investors are often presented with an ‘information memorandum’ or a ‘product disclosure statement’ that sets out information together with associated risks about the fund (Disclosure Document). While this document is important, it is also equally important to consider the constitution / trust deed in relation to the fund. This document definitively sets out the terms on which the trustee administers the fund and in almost all cases, takes priority over the information disclosed in the Disclosure Document. Many investors invest on the basis of the Disclosure Document alone and are surprised to find that the trustee can act in ways that may not be disclosed in the Disclosure Document but are legally permitted in the constitution. Disputes can sometimes arise in this context.
The myth of a ‘capital guarantee’: Despite what investors might be told, it is rare that an investment in a managed fund provides the investor with a true capital guarantee. An investor’s ability to maintain the capital of their investment and indeed, generate any returns/income from the capital, ultimately depends on the performance of the underlying asset that the fund invests in. If that asset fails, often so does the investment. As such, it is of critical importance to assess the fund’s underlying asset as well as the structure of the fund itself in order to understand the risks involved.
Expectations around liquidity: It is important to fully understand when and how you will be able to exit the investment by considering the constitution and Disclosure Document carefully. Depending on the nature of the underlying asset, some funds provide no opportunity to exit in the short term or may only provide limited exit opportunities during certain ‘exit windows’ and often, only in relation to a small portion of the investment. Investments in managed funds should not be treated as analogous to a bank account or bank term deposit where funds can be easily retrieved. Indeed it is illegal for some types of funds to allow investors to withdraw if the fund is not liquid.
Yes; the trustee owes fiduciary duties – but subject to the constitution: While it is uncontentious that a trustee of a fund owes duties to investors, there are often limits to that duty. The duties usually associated with a trustee are fiduciary in nature meaning that the trustee cannot put itself in a position of conflict or profit from its position. In reality though, the constitution can sometimes ‘water down’ this duty by setting out circumstances where the trustee is permitted to be in conflict (for example, permission to enter into a related party transaction) or profit (for example, the receipt of fees and commission).
Consider the ‘risks’ disclosed in the Disclosure Document: The Disclosure Document will usually set out the risks associated with the investment. Some of these risks are ‘general’ in nature in that they would apply to most managed fund investments generally, however there may also be ‘specific’ risks relating to the nature of the fund. Some risks that may warrant deeper consideration include:
Related party and conflict of interest risk: this risk appears where the fund is permitted to enter into transactions with related parties of the trustee. This is common where monies raised by the fund are subsequently advanced to other entities, assets or projects that are controlled and usually owned by the same people operating the fund. In this case, a natural tension can arise between the interests of investors in the fund and the related party receiving fund money.
Limited track record risk: this risk appears where the trustee or the fund manager has had limited experience operating funds or is newly established. In these circumstances, it is difficult to ascertain whether the trustee or fund manager has had a proven track record of competently managing funds / investments on behalf of passive investors.
Third party fund manager risk: the trustee of a fund and the person that is tasked with the day-to-day operation and management of the fund (that is, the ‘fund manager’) is frequently not the same entity. While the ‘trustee’ might be a well-established professional trustee, the trustee may have only limited involvement in the management of the fund as such role is delegated to a separate fund manager entity with a limited track record. At times, it might be more important to direct your due diligence inquiries towards the fund manager more so than the trustee.
The majority of our clients have held successful investments through managed funds and developed great relationships with their fund managers. Part of that success arises from fully understanding the nature of their investment upfront so that the expectations going forward are clear from both sides.
However, things sometimes to go wrong, particularly where investor expectations in relation to how the fund performs and is operated are unmet. While fund documents are often drafted in favour of the trustee and fund manager, there are a number of common law and statutory remedies available if you feel you have been misled, including those arising under the Competition and Consumer Act 2010 (Cth) (and the Australian Consumer Law under that act), the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth).
Hope the above is helpful. If we can be of assistance in relation to your managed fund investment, please feel free to get in touch with us.
This publication was written by Winston Lay, Director.