Although separately managed accounts (SMAs) have been around since the late 70s, the bulk of the attention from the industry has occurred primarily over the past decade-as a countermeasure for online trading in the mid-90s, and escalating during the market plunge of the early 2000s. Today, separate accounts sport a different look and feel today than they did even a couple of years ago.

Technology has increased the ease of incorporating separate account business into a practice, enabling greater access for independent advisors in the process. Not so long ago, independent RIAs had to practically clone themselves to do all the work necessary to include separate account business in their practices. Each part of the process had to be done individually, and the majority of those processes had to be implemented manually. Many invested their own money by hiring technology experts and creating, through trial and error, proprietary client profiling, asset allocation, manager databases, performance reporting and account monitoring systems.

We already know that advisors can gain access to prefabricated templates with the click of a mouse, customizing particular aspects of each part of the process according to their and their clients' needs. Getting started in the separate account business is now relatively easy-once an advisor knows where to go and the steps to get there.

But What Are Those Steps?

There's plenty of talk and reading materials on the benefits of doing SMA business, both to advisors and to their clients. But trying to find a step-by-step guide toward that end, or struggling through it alone, can paralyze otherwise self-starting advisors. An advisor can do his or her own research, and can talk with colleagues about their experiences in building an SMA practice. Inside knowledge gained by advisors who have mined the separate account field for years helps cut the learning curve short. This article will attempt to provide some pragmatic pointers for those who have been considering adding separate accounts to their slate of offerings, by sharing insights from successful advisors.

Here are just a few of the critical questions we will address: How can advisors find out about separate account platforms? What kind of questions should be asked in evaluating them? How does an advisor negotiate the best service from the platform chosen? How should advisors educate clients regarding the reasons for using separate accounts? Fielding Miller, CEO of CapTrust Financial Advisors in Raleigh, N.C.; Tom Carstens, a partner at Lenox Advisors in New York; Chris Jones, CFP, and Steve Coggins, partners at Jones Coggins & Co. in Wilmington, N.C.; and, Gary Bramon, CLU, ChFC at Alders Financial Solutions in Novato, Calif., offer their insights into the steps they would take if they were just beginning to incorporate separate accounts into their businesses today.

Manager Search Or Platform?

According to Coggins, the first step (after you decide to do your own search and evaluation) involves a change in mindset in selecting money managers. Miller agrees, and advises looking at the choice of money managers from the perspective of building a niche for your business. "In the life cycle of a money manager, the best performance typically occurs when managers are younger (not too young), their portfolios are not quite so large, and they're excited about managing money," he explains. "As they grow larger, they get to a point where that excitement turns into a search for relative performance. They want to keep the assets they've garnered, and they realize that if they turn in performance that's not too far off the benchmark, they'll be able to stick around."

Miller goes on to explain that by researching smaller, specialized managers-and only those who invest a significant portion of their own money in their portfolios-"All of a sudden, you have a theme to your business and a point of differentiation you can carry out into the market." It can be tricky to find such managers, but it can be done.

An entire volume can be written about doing manager searches, using software and available databases like Mobius' M-Search. But most will prefer to use a platform. Suggested steps include calling the managers themselves to get their recommendations on which platform to use. Of course, if an advisor has a broker-dealer that has developed its own platform or that has customized a third-party platform, all the advisor has to do is to plug into that system to get started. If the advisor has confidence in the due diligence and other services the broker-dealer provides, such plug-in style platforms can be the easiest and quickest way to gain access to everything needed.

Bramon employed this approach with LPL Financial Advisors' system, and has one piece of additional advice. "For advisors starting today, I would recommend opening their own account (with a money manager) first. I'm really a believer in not selling something that you don't own yourself. Although it may be impractical for advisors to open three or four different accounts of $100,000 each, most established advisors who are ready to do SMAs have enough personal assets to open at least one."

All advisors interviewed for this article unequivocally advised starting with only one platform. Carstens explains, "Starting out with more than one platform only muddies the waters and makes it very difficult for you to measure your success. Once you develop a comfort level and a good relationship with the first one, you can spread your wings a little and add a second."

Finding a list of platforms is simple. Doing a little research on Web sites for research companies such as Cerulli Associates or Tiburon Strategic Advisors, reading industry trade magazines, consulting friends about the platforms they use, or just using the platform provided by a broker-dealer will yield lists appropriate for advisors' business objectives.

Once a list of platforms has been located, how should advisors choose one with which to work?

Choosing A Platform

As mentioned earlier, the most critical component in choosing a platform, according to Carstens, is to simply interview the managers who are on them. "Frank Russell, Brinker Capital, Lockwood, Morgan Stanley, Bear Stearns-many of them have the same managers." He says the managers have given him a lot of feedback over the years about which platforms performed the most thorough due diligence. "Most managers will be pretty upfront with you. I ask them, 'If you were putting money with one of these firms, who would you put your money with?'" The managers will also inform advisors of any problems platforms may be experiencing. For that reason alone, getting the managers' viewpoints can be invaluable. Carstens advises approaching the resulting platform candidates with a specific purpose in mind. "You should find a business partner in one of those and start a relationship," he says.

Coggins and Jones add that the breadth and depth of the platform staff's research, the options available to clients and the quality of the performance reporting and back-office support are first things to examine. Viewing a platform as a business partner involves interviewing the wholesalers or other platform representatives regarding the following:

Operations and general support-will there be a team dedicated to guide the advisor in setting up the business relationship?

What does their performance reporting cover, and what do the platform's statements look like? Statements that are easy for clients to understand will help in review sessions.

What services are provided? What about future services?

How many assets under management are required to garner the best responsiveness and support of the platform? How does that affect accessibility to managers by the advisor? By his or her clients?

Does the platform allow the advisor to privately label reports, recommendations, statements and commentary?

Scalability is also a big issue, according to Coggins. The platform he and Jones use, ADVISORport, was small when they first entered the separate account business. "But even then, the scale to help clients manage $500,000 or $500 million was immediately available. The scalability of the infrastructure is extremely important."

Product offerings are another important area. Platforms such as Wachovia are now providing independent advisors with additional client services such as lines of credit, mortgages and trust services. Access to multistrategy accounts with overlay tax management, nonpublic REITs and alternative investments such as hedge funds and private equity should also be included in the criteria. "Staying on the cutting edge is important-it's all about delivering the best solutions to clients," adds Coggins. Finding as many of these services all on one platform will ease reporting, allow as much information as possible on a single client statement and will reduce operating problems.

"Make sure the fee structure is competitive," says Carstens. If the platform fee is competitive, it makes it easier for the advisor's fee also to be competitive. However fees are structured, Carstens adds, they need to be consistent across the client base. Miller recommends unbundling fees and only using one custodian. "The best thing you can do is align yourself with a broker-dealer who can custody and pretty much do business with anybody," he explains. "Find a custody partner that is very flexible and competitive. I would want the manager's fee, the trading (and I wouldn't get paid on that) and the consulting fee all to be separate."

What if you make the wrong decision? "People make wrong decisions in life, and you just have to be a grown-up and be willing to start over," says Carstens. Even so, little that would be involved in such a realization would affect clients. "Primarily, it affects how you run your business."

Finding The Best Managers

Finding smaller, niche managers as Miller suggests can be difficult, but it's doable. As he mentioned, the managers should have the majority of their personal assets invested in the portfolios they manage. "They also should be less focused on style-box purity. I think that's overdone. If they've got more flexibility, they'll be more focused on research and not staying within a style box. I would only do business with a manager who does his own research and goes on-site at companies in the portfolio," he explains.

By researching small managers, advisors can develop a niche to their business that they can take into the marketplace, says Miller. "We think that advisors would have a much more compelling value proposition if they could build their practices around identifying and monitoring the 'undiscovered' managers that are in the earlier stages of their life cycles as firms. Advisors must match this service with the research that proves the merits of catching these managers early. I feel sure that it would be easy to illustrate how managers' performance deteriorates after they enter the broker wrap programs," he says.

Most experienced advisors have a network of colleagues through which they can discover quality niche managers. Sometimes, clients also will ask advisors to research managers that they or their friends and business associates have used. Some platforms such as Brinker Capital also will have a few managers not commonly offered by other platforms, in order to differentiate themselves.

According to these criteria, with larger managers the platform is the most important decision. Two of the advisors interviewed felt that using large managers was not advisable because so many are chasing benchmark-type returns that they change their style to match the index they are targeting. In such an instance, passive management may be a good alternative and will provide lower fees.

Time Wasters-What Not To Do

Due diligence on managers can be leveraged according to the quality of the platform's research. "Any time a new manager is added, I still find a way to have them come in or do a conference call just to kick the tires myself," says Carstens. But being able to leverage off of a platform's due diligence saves valuable time that could be spent building business or servicing clients.

Many advisors looking to incorporate separate accounts want to lay all of a platform's managers side by side and compare performance. "That's the worst place to start," says Carstens. "There's a lot of manager overlap among platforms, number one, and number two, you can't really tell what's going on by just looking at the numbers."

And again, don't start with more than one platform. Starting out with only one allows an advisor to test the service quality, since larger assets open the door to greater access to, and attention from, the platform's support team.

Transitioning Clients And Other Tips

The most important aspect of preparing clients for the change is in letting them know what to expect. "Let them know the differences in fees, the way decisions will be made," says Carstens. "Identify the advantages and let them know what it's going to look like for them." Also, explain that clients will see all the trades being made and that no one will be calling them to do a trade. "These managers are in the trenches every day-they're far smarter than you or I will ever be, so we want to give them full discretion," is an example of what to tell clients.

Aligning with a "study group" is a suggestion offered by Bramon. "There are six of us who meet every couple of months. We're all LPL people and we discuss ideas, what's going on and what we think about our experiences," he explains. "We're all from different backgrounds-brokerage, banking, insurance-and we set an agenda the month before and everyone is assigned a topic."

Attending conferences held by industry organizations such as the Investment Management Consultants Association, the Money Management Institute, the Financial Planners Association and the Financial Research Association can help advisors keep up with industry trends in SMA product and service offerings, as well as technology development.

"I've found such conferences to be very beneficial on how institutions do the asset allocation and how managers actually run their businesses," explains Carstens. "That's how I learned about open architecture and how I keep up with what's going on."

Just The Beginning

This is a sneak peek at some of the inside perspectives offered by the veterans who have developed a successful SMA practice. There are other elements to the SMA process, of course, such as what oversight, maintenance, monitoring, and follow-up is required with both the client and the managers after the platform is chosen and the separate account is opened. We'll be covering these issues and more over the following months to give the best advantage and an easier learning curve for building an SMA business.

Veteran financial writer and former wealth manager Lisa Gray assisted with the research for this article.