Interest in separately managed accounts from individuals has grown dramatically during the last five years, as firms have stressed their advantages and reduced investment minimums to $100,000 or less. But the accounts aren't as well understood as mutual funds, nor is information about them as easily accessible. In fact, some say demystifying the accounts could help the industry grow.

According to the Money Management Institute, individuals had approximately $382 billion in such accounts at the end of the first quarter. That amount was a fraction-only about 6%-of the more than $6.6 trillion in mutual funds, but the number is more than twice as high as it was at the end of 1996, when MMI began keeping statistics. Industry executives are optimistic that growth will continue as more people become wealthier and want the advantages they offer.

"I do think it will continue," says Kietha Kinne, senior vice president at Newark, N.J.-based Prudential Investments, which offers about 115 separate-account strategies. "Just the enormous growth in the market itself has created a world in which there's been an irreversible raising of awareness of the financial markets."

One advantage of separate accounts is they are managed to lessen the tax impact from investment transactions. "The reason people are coming to managed accounts is they've realized in creating wealth, it's not what you earn, it's what you keep. If you look at the expenses of investing, management fees might be 1.5%, but taxes can be between 20% and 40%. That's a huge hurdle," says Len Reinhart, chairman and CEO of Lockwood Financial, based in Malvern, Pa., which offers managed a

counts and other services for high-net-worth investors through about 1,000 independent advisors.

Another advantage: The cost basis of equities is the price at which the shares were purchased for the individual's account. With mutual funds, owners inherit the cost basis of existing holdings when they buy into a fund. That condition made taxes a big issue last year for many mutual fund shareholders, who had to pay taxes on 2000 capital-gains distributions resulting from managers selling low cost-basis stocks in a year when equity prices sank and depressed net-asset values.

Another attraction resulting from the accounts being individually managed is investors can request restrictions, such as prohibiting the sale or purchase of certain stocks. That can't be done with a mutual fund because an individual's investment is commingled with others and the total is managed together. Many investors also like the fact there's usually just one asset-based fee for all the services provided through managed accounts.

Managed accounts offer advantages over mutual funds, but they aren't always the best choice. In the emerging-markets and international-bond categories, for example, expenses typically are far greater going the separate-account route than with mutual funds, Prudential's Kinne says.

Although managed accounts may possess more intrinsic tax efficiency than mutual funds, clients can get hit with big tax bills when they decide to dump a manager, says Judy Shine of Shine Investment Advisory Services in Englewood, Colo. And separate-account managers often are more inclined than their mutual fund rivals to overweight a few stocks that may cause huge swings in returns, she adds.

But perhaps the biggest issue relating to private portfolio managers is how their performance should be assessed.

In particular, making sense of composites can be time-consuming. The composite of accounts managed in a particular style presents an overall return, but the experience in any one account-particularly one that has specific objectives or restrictions-may vary significantly. Managers don't have to include all accounts managed in a particular style in a composite, and which accounts are included will affect the result. Standards set by the Association of Investment Management and Research have helped improve performance reporting by managers, observers say, but more standardization is needed. Mutual funds, on the other hand, have had standardized reporting for many years.

"AIMR is a perpetual work in progress," says Glenn Regan, senior vice president and director of research for Salomon Smith Barney's Consulting Group, which has more than 9,300 advisors and is a major player in the managed-accounts business. "They've taken a stab at some nasty issues, and they've been reasonably effective. More needs to be done, and they are doing more."

Because judging private portfolio managers is a very involved, ongoing process, many independent financial advisors who don't want to dedicate the time or don't have the expertise for such analysis turn to third-party firms, such as Lockwood and others, to select them for their clients. Advisors who work for large brokerages that offer managed accounts for individuals usually can rely on their firm's research staff to evaluate and select managers.

"The ongoing due-diligence issue is huge," comments Rob Fletcher, Shine Investment Advisory's chief investment officer. "After the initial analysis is done, advisors need to continue to study the manager for adherence to the investment process, changes in philosophy, personnel, style drift and a host of other issues on an ongoing basis. The cold, hard truth is managers do change, and advisors must be vigilant." Shine, which has about $260 million in assets under management, uses third-party providers Investment Consulting Group and Portfolio Management Consultants, both in Denver, and StockTrib in San Clemente, Calif., to supplement and extend the analysis and selection it does internally.

Lewis J. Walker of Walker Capital Management Corp. in Norcross, Ga., uses Lockwood to provide managed-account services to his clients, but his firm often does due diligence on its own. "You narrow the field to one or two providers at most. If you look at trends in money management today, you have to be extremely efficient. This is more economically efficient," he says.

Firms that evaluate and select portfolio managers often start by running screens on various private databases-such as CheckFree Investment Services' M-Search (www.checkfree.com), formerly Mobius, or Effron's PSN (www.effron-psn.com). Some lower-cost databases also are available, such as Money Manager Review (www.ManagerReview.com), which offers subscriptions for less than $300 annually. Some databases are very comprehensive, but managers give information voluntarily to them, so who's listed, analysis and other details can vary. Some companies who want as complete a picture as possible buy the services of more than one provider, while others require a portfolio manager to participate in a particular database before they will consider using him or her.

One piece of information that some databases don't include is whether a manager takes accounts of individuals or focuses only on investing for institutions. Money Manager Review, for one, does list whether a manager takes wrap accounts. Jamie Waller, a senior vice president at CheckFree Investment Services, says M-Search now is asking about individual wrap accounts in its questionnaires and will include the amount a manager has in them.

In addition to screening databases and considering any analysis provided, firms crunch numbers themselves. "We do risk-adjusted measures, rolling-period analysis that tries to smooth performance over longer periods, style analysis and universe rankings to see how they compare. We focus a lot on consistency," says Steve DeAngelis, president and cofounder of ADVISORport, a Plymouth Meeting, Pa., company that works with 35 investment-management firms offering 55 products for advisors.

Quantitative research may be where firms start the selection process, but they then move to a qualitative phase, and that's where approaches differ more markedly. As part of the process, firms often hold conference calls and on-site visits to supplement information they collect.

"We believe a lot of the real value comes in on the qualitative side," DeAngelis says. "It's more the art than the science. We look at whether there's a well-defined investment process. Is there a lot of dispersion across accounts? Do they have systems and processes to meet individual portfolios, such as specific restrictions for taxes?"

Regan of Salomon Smith Barney's Consulting Group says performance isn't as important as other factors in the selection process-a "very qualitative and very rigorous" one-used by the firm's fiduciary services program, which handles managed accounts for individuals and involves 69 analysts. Regan says his team also looks at an organization's structure, legal and compliance issues, whether clients are treated equitably, stability of key employees, whether investment personnel are dedicated to the investment function, whether managers can define clearly what they find attractive when making investment decisions, oversight procedures and style consistency.

Prudential Investments has a group of analysts who rely on a 10-step model to assess portfolio managers. Investment-team talent, experience and stability, as well as the investment process, the firm's management and ownership structure, client servicing, compliance and ethics are among the areas considered.

Firms say they will change portfolio managers if necessary. "Yes, we do fire managers," Regan says. "When they are hired, they shouldn't look at it as a lifetime assignment. People change over time. Organizations change over time. Some changes can be good, but some aren't so good. Sometimes, it's exactly the same organization, but world changed and they didn't."

With more individuals interested in managed accounts, does it make sense to require private portfolio managers to report performance information-particular composites-publicly? Would it be helpful for the industry, as well as investors?

Thomas M. Kostigen, editor-in-chief of Investment Consulting News, which is published by the parent company of Financial Advisor, has been outspoken in his view that performance information should be made public. He maintains firms are resistant to reporting composite numbers publicly because fees have to be calculated into performance, and fees aren't consistent. "A lot of older accounts have 3% fees on them. Managers are afraid of waking up investors to the fact that they're paying a fee," he says.

Despite some limitations, Kostigen says, composites would provide an indication of performance without interested parties having to spend big bucks to get it from private databases. With that information, investors could compare performance of managers offered by different firms. "You can't compare, and that's what they want. You can't compare how their managers are performing versus others without having to pay thousands to get it," he says.

Industry representatives interviewed agree they favor information being public and believe more information is usually better. But they questioned the value of requiring private portfolio managers to publicly report performance. "It probably would help the industry grow to get stats out there, but I haven't seen the packaging of the information where anybody could go out there and say, 'These are the results,'" Lockwood's Reinhart says.

"From my own perspective," Kinne of Prudential says, "I don't see a reason to require it. It would promote the concept of screening just on performance. The information is available, it's just not easily accessible."

With separate accounts, as well as mutual funds, a good advisor makes the information meaningful to clients, she adds. "Most people come in looking for a solution. They don't come in saying they are here to evaluate money manager X. There are some people who are equipped with that knowledge and are willing to dedicate an ongoing effort to pulling it together, but for more and more people, they are starved for time. It's not that they're lacking information," Kinne says.

Peter Walker, founder and editor of Money Manager Review, says broad guidelines may make sense to reduce the potential for misleading information. "There may be certain accounting practices the government may want to specify that managers follow," he says. "The issue is whether numbers should be reported on a gross or net basis. The problem with that is managers have break points on fee rates, so the larger the account, the smaller the fee, which then distorts the performance measures. If you have a lot of large accounts, it makes fees look smaller. One size doesn't fit all. This is something where there needs to be a certain amount of flexibility."

While the difficulty in providing standardized information is obvious, some observers think that the managed-account industry's agenda is to maintain its control over information. Information is power, and if public performance reporting is required, advisors and even some investors would gain knowledge in the process. Ironically, that might be what the managed-account business needs to advance to the next level.