Investment custodians have an important function to safeguard the assets of millions of Australian investors.
You may not realise it. But if you’re a member of a superannuation fund, or an investor in a managed fund, there’s a high chance your investments are being held for safekeeping on your behalf by an independent third-party custodian.
Who are these custodians? Think of them as the professional guardians of a significant portion of the assets underpinning the wealth of millions of ordinary Australians.
They’re licensed, regulated and typically bank-owned entities that are entrusted with the custody of trillions of dollars of assets such as shares and bonds that institutions, including big global investment managers such as Vanguard, have invested in on behalf of their own investor clients.
By using external custodians, investment managers can stick to what they do best – focusing on investment strategies that give their investors the best chance of investment success.
According to the Australian Custodial Services Association (ACSA), the peak industry body for custodians and asset service providers in Australia, there were more than $4.3 trillion of assets held under custody for Australian investment institutions as at 31 December 2022.
These include assets invested through investor directed portfolio (IDPS) platforms such as Vanguard Personal Investor. Outside public offer superannuation funds, IDPS platforms are the most common way for Australians to access unlisted managed fund investments.
Separately, research firm Rainmaker Information has estimated that 36% of the shares on the Australian Securities Exchange (ASX) are held under custodian structures for Australian superannuation funds on behalf of their members.
What is custody?
In general terms, custody is the provision of asset safekeeping and trade settlements.
When you invest in a managed fund you are buying units in that fund and the fund owns the underlying investments on your behalf as responsible entity or trustee. Your money is pooled with other investors.
Under custodian arrangements, investors have beneficial ownership of their investments while the custodian holds the legal title as their agent and bare trustee. In this capacity the custodian is legally obliged to hold investors’ assets in safekeeping on their behalf, subject to their instruction and for their benefit.
That’s important for investors, because one of the most important protections and controls against fraud is the separation of the safekeeping function from the investment function undertaken by asset managers.
In many cases, a custodian will also provide investment administration and other custody-related services including portfolio valuation, tax records, regulatory reporting, and unit pricing.
What are the benefits for investors?
There are significant benefits from the use of custodians by institutions such as superannuation funds and asset managers who are able to pool investors’ funds together to undertake investments and have these investments held in safekeeping by external custodians.
Traded market securities held by custodians and their nominees are typically registered or held in what are known as omnibus accounts. An omnibus account is a single account in which the assets of many clients are pooled.
For example, shares listed on the ASX may be held in a single CHESS (Clearing House Electronic Subregister System) account, with a single holder identification number (HIN), with the custodian’s systems tracking individual client beneficial ownership.
The main benefit of an omnibus custodian model and the pooling of assets are the efficiencies of scale from an operational and costs standpoint.
The use of omnibus accounts brings considerable efficiency to investor servicing, as several functions can be undertaken once, rather than many times.
For example, as the custodian of the managed fund assets held within Vanguard Personal Investor, Vanguard is able to aggregate the trade instructions received on a daily basis for each managed fund.
These are then netted off against each other so Vanguard’s investment teams only need to trade the net cash flow (whether that’s net inflows to be invested or net outflow to be divested).
This approach minimises the turnover of assets in the funds and lowers trading costs overall.
Vanguard’s custodian structure
Each Vanguard fund is established as a separate legal entity with its own constitution, and an external custodian has been appointed to hold the listed assets of each fund in safekeeping.
While Vanguard’s fund managers determine the trading strategies behind each fund, the custodians control the delivery of the fund’s listed assets based on the daily transactions between individual investors.
In the case of the Vanguard Personal Investor platform, Vanguard is the custodian of the unlisted managed fund units held on trust for investors who invest through the platform.
The global investment bank JP Morgan Chase Bank, N.A. has been appointed as sub-custodian for the listed assets held on the platform, such as ETFs and ASX-listed shares.
Tony Kaye, Senior Personal Finance Writer