As fee-oriented investment management becomes more popular with advisers and clients, fee-structured accounts are growing apace. Or not, depending on how the terms are defined.
Chip Roame, managing principal of Tiburon Strategic Advisers, focuses on what he calls traditional separately managed accounts, third-party managed individual accounts for the high-net-worth market. "It's become a sleepy business," Roame said. "There's still low adoption outside of the wire houses. Independent advisers are content with mutual funds and, recently, with ETFs."
Roame noted that the Money Management Institute now addresses a wide variety of fee-based accounts, not just traditional SMAs. Indeed, the MMI uses the term "managed solutions." In addition to traditional SMAs, the managed solutions category includes multidiscipline portfolio programs, unified managed account platforms, unified managed household platforms (UMHs), mutual fund advisory programs, exchange-traded fund advisory programs, rep-as-adviser programs and rep-as-portfolio manager programs.
Business overall is booming. From mid-2009 to mid-2010, total managed solutions assets rose more than 27%, to over $1.75 trillion.
The Standard & Poor's 500 and the Russell 2000 indexes were up 14% and 21% in those 12 months, so cash is flowing into managed solutions, where asset growth has outpaced price appreciation.
Jean Sullivan, managing principal of Dover Financial Research in Westwood, Mass., which compiles data for the MMI, said that managed solutions assets peaked in the fourth quarter of 2007 and reached a low point in the first quarter of 2009. But "since then, they have nearly come back to the previous high," she said.
The same statistics that indicate growth in managed solutions also bear out Roame's contention that the traditional SMAs segment has been caught napping.
They grew by only 6% from mid-2009 to mid-2010, and traditional SMAs now account for 28% of the managed solutions assets tracked by the MMI, down from nearly 34% a year ago. SMA assets in mid-2010 were down by more than 35% from their peak at the end of 2007, even though managed solutions assets have recovered.
"SMAs imploded during the financial crisis," Sullivan said. "They tend to be equities-oriented, so they were hurt when stocks fell. They turned out to be inflexible, and some investors had a difficult time moving to cash." High minimum investments and a lack of adviser control are other factors in flagging interest in SMAs, she said.
Roame said an increased focus on cost savings driving financial advisers toward ETFs also is costing SMAs market share, he said. Second, equity markets are becoming more correlated, which is causing some advisers to use hedge funds instead of SMAs. Third, the traditional tax advantage for SMAs is lost in a poor market, he added. SMAs are known for their customized trades, which can minimize taxes, but capital gains tax might be a minor concern when so many investors' holdings are underwater.
Sullivan cited some of the same trends as Roame. They are apparent inside as well as outside of managed solutions, Sullivan said. "There has been an increase in alternative assets because they are not correlated to other classes," she said.
Hedge funds, for example, increasingly are showing up within managed accounts. Managed futures and commodities also might be available through managed accounts; mutual fund wrap programs might include funds that mimic hedge fund strategies such as going long and short.
Sullivan is also seeing a trend toward problem-solving. "A few years ago, advisers were trying to fill parts of the nine-category style box," she said. Now they are more likely to be looking at theme-based portfolios.
In addition, more advisers are using tactical strategies in managed solutions. "Buy-and-hold strategies are still used, but some advisers want more fluidity in their portfolios," Sullivan said.
Thus some of the broad investment trends that have surfaced in recent years — alternative investments, tactical asset allocation — can be found in managed accounts. Sullivan also said that these programs generally have become more conservative, with an increase in fixed-income strategies.
MMI/Dover data shows a steady growth of fixed-income SMA objectives matching a steady decline in domestic equity objectives. In mid-2010, domestic equity held a scant lead, 40% to 37%. Among model portfolios, taxable fixed income tops the list with 22.4% of assets, ahead of large-cap value (19.1%) and large-cap growth (17.8%).
While taxable fixed-income SMAs are the leaders, municipal fixed income doesn't even make the top 10, holding less than 2% of portfolio assets. "Many investors in fixed-income SMAs are nontaxable, such as 401(k)s and pension plans," said Randy Dry, managing director of the institutional group at Thornburg Investment Management in Santa Fe, N.M. "They hold taxable bonds, Treasuries, agencies, corporates and some asset-backed securities."
Asked why investors want to hold bonds, taxabale or tax-exempt, through managed accounts instead of a bond mutual fund or a low-cost ETF that tracks a bond index, Dry said: "For the same reasons that you'd use separate accounts for equities. Investors own the underlying securities, not shares in a fund. You can make trades that improve your tax position. And you avoid the 'flow shock' that may affect mutual funds."
Beyond investment choices, Sullivan describes some changes in the managed accounts universe. While traditional SMAs have slipped from 34% to 28% of managed solutions assets in the past year, rep-as-adviser and rep-as-portfolio manager strategies went from a combined 34% share to 38%.
"Many advisers want more discretion and control over how client assets are invested," Sullivan said. Rep-as-portfolio manager strategies, where advisers have full discretion, are growing more rapidly than rep-as-adviser programs.
Sullivan added that both of these strategies may require more work from the financial adviser, compared with other types of managed solutions strategies. "Since the financial crisis hit, though, many advisers are feeling the need to prove that they add value," she said.
The rise of the two rep-oriented strategies mirrors a change in the overall picture. In the past 12 months the wire house share of managed accounts has fallen from 64% to 61%. While the wire houses (Morgan Stanley Smith Barney, Bank of America Merrill Lynch, Wells Fargo, UBS) increased managed solutions assets by 21%, non-wire-house firms such as Charles Schwab, Fidelity Investments, Ameriprise and LPL increased their assets by almost 39%.
While some advisers want to be more involved in investment decisions, others are looking to offload those responsibilities. Sullivan said there has been lots of interest in UMAs, referring to programs in which a single account holds multiple types of investments. "UMAs relieve reps of some investment activities."
From mid-2009 to mid-2010, UMA assets grew by more than 73%, according to the MMI. In the second quarter of 2010, UMA programs had $6.7 billion of net sales, which accounted for 16% of the managed solutions total, while traditional SMAs had modest outflows.
"Administering managed accounts can be a headache for advisers," said Kevin Crowe, solutions unit leader at SEI Adviser Network in Oaks, Pa. "They may have to deal with investment customization, rebalancing and reporting. A UMA can do that for reps; a majority of our business now is in UMAs."
With UMAs, advisers generally are not responsible for manager screening or securities selection. "We do those things for them," Crowe said.
UMA sponsors are now developing the next stage in the process, Crowe said — the UMH account. These accounts aggregate multiple accounts, including 401(k)s and individual retirement accounts, to help provide comprehensive investment management. "These accounts may help to resolve issues such as where should specific types of assets be located, in a taxable account or in a tax-advantaged retirement account," he said.
Crowe said the world of managing solutions now offers an appealing choice to financial planners. "It depends on how much investment management and due diligence they want to do."
Planners who want to be actively engaged in investment decisions, or who work with a firm that can supply the necessary expertise, can choose the rep-as-adviser or rep-as-portfolio manager modes. Alternatively, advisers who would rather spend their time on financial planning or client contact can choose a UMA or a UMH strategy and outsource many of the asset-allocation, securities selection and investment tax planning decisions to other professionals.
Nevertheless, a recent report by Cerulli Associates called adviser adoption of UMAs "uninspired." While the growth rate has been strong lately, the base remains small; both Cerulli and the MMI report that total UMA assets are barely 4% of all managed accounts.
Cerulli said there are three reasons advisers balk at UMAs: they might be too set in their ways to try a new concept; they may find UMAs less appealing than other types of managed accounts; or they may believe that UMAs are too complicated. And some advisers may believe that UMAs are appropriate for only certain clients — those with too many assets to be well served by a mutual fund wrap program yet too few assets for a suite of SMAs.
Beyond those reasons, Cerulli focuses on the trade-off facing advisers.
"Because most UMAs require some element of home-office discretion, it is worthwhile to look at circumstances where an adviser would be more willing to give up discretion," the Boston research firm said in its report.
Advisers might cede some control over portfolio construction for exposure to alternative investments, tactical asset allocation, offerings with principal guarantees and tax efficiency. They are more likely to let UMA sponsors make investment decisions on behalf of clients, while those who want more input may prefer other solutions.
