The more money people have, the more they expect to get preferential treatment. No surprise there. In the world of investing, however, our research among a variety of affluent audiences underscores the fact that they're finding that preferred treatment by moving up from mutual funds to managed accounts.
Mutual funds, of course, have dominated the investment landscape for years, and, with the Investment Company Institute estimating that there are now 88 million Americans with better than $7 trillion in assets under management, they're still the lead story for investors as a group. But the more affluent segment, the very investors who are the most prized clients of financial advisors and institutions, are the ones who most readily are turning to managed accounts.
Although the estimates vary, there's no argument about the increase in popularity of managed accounts and the prospects for continued growth. A recent study by Cerulli Associates estimated that managed account assets under management rose from $75 billion at year-end 1994 to $275 billion in March 2001, an increase of 266%. Cerulli predicts that the figure will reach $650 billion by year-end 2005. The Money Management Institute estimates that the top five firms that collectively hold about 70% of the managed accounts market-Merrill Lynch, Morgan Stanley, UBSPaineWebber, Prudential and Salomon Smith Barney-had $276.5 billion in assets under management at the end of the first quarter of 2001, up from $245 billion at the end of 1999. And Financial Research Corp., taking the most bullish view, estimates that assets under management already exceed $1 trillion and are growing at 30% annually as compared with mutual fund assets, which are growing at 22% a year.
What Is A Managed Account?
The Money Management Institute, the national organization for the managed account industry that represents portfolio-management firms and sponsors investment-consulting programs, defines a managed account as an "individual investment account offered by financial consultants who provide advisory services and managed by independent money managers using an asset-based fee structure. It combines several services in a customized solution to investing, including planning, policy development, manager search and selection, portfolio management, performance management and trade execution-all for a single fee." The fee is a fixed percentage of assets. And though new players are bringing the cost of entry down, managed accounts usually require an initial investment of at least $100,000, representing the middle ground cashwise between mutual funds, some of which have no minimum initial investment, and high-end hedge funds, which cost as much as $1 million to get in the door.
For investors who can afford them, there's no question that managed accounts offer benefits. First and foremost is the fact that a managed account is customized to an individual investor's specific financial goals and objectives. Some investors put money into mutual funds based on the advice of their advisors, who usually have a pretty good idea of their financial picture and aspirations. But a lot of people, even those with advisors, will invest in mutual funds based on what they're read on the Internet, seen on CNN or heard from friends. And, acting on one's own, it's hard to keep track of diversification and an asset-allocation strategy, as those many investors who were overweighted in growth stocks and funds during early 2000 can testify. With a managed account, a comprehensive process is part of the fee, beginning with a detailed questionnaire and moving on through an asset-allocation strategy that reflects each investor's risk/reward preferences. After that, the managers who are best suited to pursue that strategy are selected for the portfolio, their performance is monitored, and each manager is accountable to the individual investor.
The Tax Picture
No one likes to pay taxes, and one of the main attractions of managed accounts is their tax efficiency. Because it's an individual account, the portfolio can be managed with an eye to reflect an individual's tax status. For the account manager, that could mean taking an increased cash position at certain times, for instance, or choosing to sell an equity at a loss to offset gains. A lot of mutual funds that had losses in 2000 still had tax bills for realized capital gains.
Other important benefits of managed accounts include:
A Single Fee: Though the asset-based annual fee of about 3% is higher than that of mutual funds, which is closer to 1.4%, it's also more comprehensive, including investment counseling, portfolio management, brokerage fees and ongoing account administration. Many separate accounts are now below 3%.
Control: Investors can make specific portfolio requests, such as asking the manager to avoid holding certain stocks.
Ownership: Unlike a mutual fund, in which the assets are pooled, individuals own the securities they hold.
Managerial Talent: One of the biggest drawing cards is access to some of the nation's top money managers. And the performance of those managers is monitored, which comes as a relief to mutual fund investors, who have to keep track of whether the manager who drew them to a fund has left and whether the fund itself suffers from style drift, shifting from value to growth to chase returns.
Peace Of Mind: We all know how complicated investing has become, with information overload, volatility and talk of a coming (or going?) recession. Add to that the fact that there are more than 8,000 mutual funds from which to choose, and a number of affluent investors prefer the simplicity of putting their money into a managed account.
Cachet: Though one stop short of the ultimate cocktail-party conversation piece, the hedge fund, managed accounts definitely have a psychological appeal that puts them a notch above mutual funds, an investors' club that is less desirable because just about anyone can get into it.
As noted, our recent research among a variety of affluent investors shows that their interest in managed accounts increases along with their wealth. Whether they are e-millionaires, people who have made their money through the Internet; those who have become millionaires through inheritance; or "middle-class millionaires," baby boomers who, to their own surprise, have become millionaires through IRAs and pension plans, managed accounts are an investment of choice. About a quarter of each group already have managed accounts and more than half were interested in them. As for the reasons for their interest, middle-class millionaires cited:
Access to unavailable money managers: 91.1%.
Tax efficiency: 38.7%.
An asset-based fee structure: 16.9%.
An all-inclusive fee structure: 13.7%.
In yet another recent study of 247 affluent investors who already had managed accounts, we asked them to rate the features on a scale of one to 10, and the following were the top three reasons:
The investment program is managed to a specific requirement: 9.1.
Objective periodic performance reviews: 8.6.
The choice of prescreened investment managers: 7.8.
The Mutual Fund Competition
None of this has been lost on mutual fund companies, of course. "Managed accounts are perhaps the single biggest threat to mutual fund assets because of their well-chronicled advantages, which include tax efficiency, portfolio flexibility, fee-based pricing, and cachet," says T. Neil Bathon, president of Financial Research Corp.
So a number of mutual fund companies are moving into the managed accounts arena, not just to get a piece of the growing business, but also to keep current investors in-house. High-net-worth investors, in particular, are most likely to move their money from mutual funds to managed accounts, and they have an estimated $2 trillion in mutual funds, a sizable percentage of the $7 trillion whole.
The move to managed accounts won't necessarily be easy, however. Though mutual fund companies obviously have their share of managerial talent, the institutional money managers who currently dominate the managed accounts market have more experience dealing with affluent investors and understand the handholding and personal attention that's involved. Mutual fund companies, according to Financial Research Corp., also will have to improve their back-office processing, wholesaler training, compensation, shelf space, industry experience and track records before they become a serious threat to the current managed account market leaders.
Hannah Shaw Grove is managing director and chief marketing officer of Merrill Lynch Investment Managers. Russ Alan Prince is president of the consulting firm Prince & Associates.