You've come to a crossroads in your career: One choice is to continue down the same path. Another option is to take a chance and choose a route that could significantly change your life and your business. Think of it as "Separately Managed Accounts" or "Business as Usual."

Before you make your decision, though, why not take an introspective journey to determine if marketing managed accounts is really for you. You'll analyze your business, your clients and your goals, and talk with colleagues about the pros and cons of the business. Soon you'll have a pretty good idea as to whether you are ready for a managed account mindset.

The first thing you should try to determine is what is most important to you in the way you run your business. Do you love prospecting? Do you enjoy working with big clients? Do you enjoy watching the market and making stock picks? Do you really love servicing your clients? Are you personally handling things in your business that you would prefer delegating to someone else? These are important questions, and your answers are critical to helping you make your decision.

Think About The Benefits

Working with managed accounts provides three very important benefits. If you're not interested in these particular bennies, or if you don't see a fit for yourself, then it may not be the business for you. Let's review them in brief:

1. Separately managed accounts allow you to remove yourself from the process of managing money. You can eliminate the problem of not having enough time for yourself and your business and delegate this responsibility to a professional money manager. You also can eliminate the perceived conflict of interest that sometimes is associated with transaction-based business, and literally sit on the same side of the table with your clients.

2. You have a better opportunity to work with very large clients. And this is the part of the managed account story that takes you down a different path. Affluent clients, for example, want personalization and customization. They want to control their tax destiny. If you want to work with wealthy individuals, foundations, endowments and small to midsized institutions, then you have to upgrade your services. This is where separately managed accounts fit in perfectly.

3. You must have the vision and presence of mind to want to build and grow your business, using the embedded return of the market to help boost your income. You can create an annual revenue stream, or annuity, that develops your business exponentially. If the markets and your investment managers have positive performance, you will receive a lift in income with little effort. In essence, if you believe in the future of capital markets, you're creating built-in raises for yourself.

Are You A Player?

As the managed account business has grown, we've seen certain types of individuals gravitate towards it. Who are these individuals and what sets them apart from the rest? Four common denominators underscore the most successful advisors:

They love to compete for business.

They have very substantial relationships, not only with the affluent, but also with foundations and endowments.

They work closely with the client's CPA, attorney, business consultant and other professionals.

They are not afraid of "big" money. They understand the benefits of leveraging the value of those relationships by having other professionals manage that money.

Working with large clients and having the confidence to handle the sale (in essence, not worrying that you are going to lose control of the client), is a function of personality and temperament. Only certain types of individuals are the right fit.

Indeed, the battle cry of some advisors who question managed accounts has been, "Why should I give up control of my best clients?" Why indeed?

The only reason you would do this is to build a solid, long-term business. The individuals who realized early on they were "in the business of building a business" were the advisors who grabbed managed accounts. And as they looked around for areas in which they could excel, the No. 1 common denominator kept surfacing-they were all really good salespeople. Advisors who didn't necessarily enjoy managing money, but who loved to prospect, could focus on doing that, could stop watching the market, stop being responsible for the individual securities selection and finally do what they loved-winning and servicing big clients.

There was a differentiation among those who were both into marketing and into sales. The advisors who wanted to run a real business didn't just sell what the firm told them to sell, they utilized marketing strategies, they started building a practice. These advisors also realized the value of leveraging their expertise and saved an enormous amount of their time by turning the management of their accounts over to individual money managers.

It's A Crowded Marketplace

If you are trying to compete on the same basis every other advisor is, what is your mark of differentiation? It is the real value that you provide. It is the counsel and the process. One of the ways to explain your value is to say, "I'm offering a serious investment process by which you can manage your money."

An affluent client will appreciate that you have a system, or process, that sets you apart from your competitors.

Stephen D. Gresham, executive vice president of the Private Client Group for Phoenix Investment Partners Ltd., is the author of Attract and Retain the Affluent Investor: Winning Tactics for Today's Financial Advisor. He is currently working on a book of best practices for advisors and brokers, from which this article was excerpted.

Lessons From The Industry's Mega-Advisors

After developing their $1 billion to $25 billion fee-based practices, many of the profession's largest advisors wished they had done certain things differently. What were those things? What can you learn from them? How can you emulate the "best of the best" to expand your business? They didn't develop their businesses by accident; nor should you.

Having interviewed many of the world's mega-advisors about how they created their world-class businesses, I discovered many key elements to their success. We discussed a host of topics, including: business philosophies, attracting and retaining high-net-worth and ultrahigh-net-worth clients, practice-management considerations and technology.

Their approaches and practices were substantially different from the vast majority of average advisors. Let's outline some of the key findings regarding their practice management issues.

The majority of those interviewed said that in their earlier years of production (all had started as retail brokers), their businesses developed in a haphazard manner.

They lacked a systematic plan for business development that, in hindsight, they wished they had implemented.

Their failure to plan and address key business-development issues decidedly slowed their business growth and allowed otherwise avoidable problems to occur.

Only a few had any predefined plan regarding exactly when they would add additional staff members or partners.

Most added personnel only when there was no choice in the matter. Now, they advise others to at least sketch out a business-development plan and identify the points at which additional personnel will be required. Adequately addressing the division of labor provides the leverage needed to jump to the next levels of professional development.

Division Of Labor

One of the most difficult challenges faced by the group was the transition from "sole proprietor" to "business manager." They couldn't provide world-class service or deal with the wealthiest individuals until they had an effective division of labor. The process involved bringing others into their business organization to supplement their own skills. As their organizations grew, the additional personnel fell into the following broad categories:

Office Manager/Administrator

Computer Expert/Technical Analyst

Portfolio Manager/Analyst

Sales/Administrative Assistants

Operations Personnel

Product/Service Specialists (internally or externally)

In all cases, adding sales/administrative assistants was the first step-one taken by most financial advisors at some point in their careers. The big jump occurred with the creation of an administrator/office manager (either by hiring or by promotion) who was given the authority to orchestrate the day-to-day management of the business. This important step allowed the financial advisor to do what he or she did best. (A key developmental challenge for anyone is to realize his/her own strengths and weaknesses and hire others to enhance strengths and compensate for weaknesses.)

For about half the group, a technology person was the next significant position to be filled. For the other half, the position of portfolio manager/analyst was filled. The technology person (whether a full-time staff member or outside subcontractor) was hired to more fully automate the office functions, eliminate duplication of efforts (double entry of information) and help ensure the delivery of a quality product. The portfolio manager/analyst developed portfolios and monitored performance. In a few situations, this latter function was filled by the original financial advisor/business owner.

Other functions were filled based upon the needs of the practice. Expertise was often needed for: taxes, 401(k) plans, investment capital, etc.

Very important observation: Virtually all of the top advisors use money management as their primary investment vehicle-essentially using outside expertise.

During the interviews, the division-of-labor questions delved into optimal organizational structures, procedures manuals, quality-control issues, managerial concerns and business valuations. The smaller practices (smaller with respect to the number of people involved) showed similar organizational patterns. The larger practices, almost by definition, required greater formality. Again, in every practice involving more than three people (the vast majority) the person deemed most vital to the success of the practice was the administrator or office manager.

The answers to the technology questions also yielded some interesting results. About one-third relied exclusively on their firm's technology and reports, but had to spend time simplifying the results for their clients. (None was willing to hand clients the massive performance reports produced by the firm's analysts. For the most part, such performance reports are too voluminous, intimidating and detailed for even the most sophisticated clients.) Another third used a combination of software from their firm and from outside vendors. The final third actually developed their own technology and, in some cases, were pioneers in their fields.

In summary, developing a highly successful financial services practice requires much more than product knowledge, good communication and rapport skills, the motivation to succeed and the right attitude. Good business practices that allow others-internally via staff and externally via money mangers and consultants-to help you leverage your time while providing additional value are vital to your ability to deliver a consistently high-quality service.

Steven Drozdeck is a financial services consultant. He has written more than nine books and courses and has trained more than 55,000 professionals. His Web-based training company, www.TheProgressCenter.com offers over 200 courses to increase productivity. He can be reached at (435) 753-8848.

Unique Platforms Equal Real Value Or Market Fragmentation?

Remember when everybody and his brother were building different systems when the PC first came on the scene? Then Microsoft created a common operating platform and licensed it to everyone. It became an industry standard that made demand for PCs explode. The same thing happened to the mutual fund industry in the 1970s and 1980s.

"The investing public became educated and started asking for them-that's when the mutual fund business exploded," says Len Reinhart, chairman of Lockwood Financial Advisors Inc. in Malvern, Pa., and co-author of a recent white paper about the long-term viability of the separate account industry.

According to Reinhart: "At the cottage-industry stage, everybody does his own thing. But if you want to grow the business by 10 to 100 times as an industry, you need standard operating procedures and protocols." Currently, administrative inefficiencies and lack of product portability are the primary obstacles to exponential growth. And instead of trending toward a common protocol, efforts to foster differentiation in the marketplace are on the rise.

Erik Davidson says firms want to differentiate themselves by using platforms with unique managers and strategies, thereby offering unique value. Davidson, the co-founder of Carmel, Calif.-based Separate Account Solutions, is a separate account platform developer and does not feel a common protocol is near. "We're seeing firms move in the opposite direction," he says.

The report says the current system creates overlap and redundancies in every tier: front-end revenue-generating tools, supporting middleware/decision-making tools, and back-office tools. The paper calls for a more open platform for trading executions. Reinhart says trades should be pooled and executed at the firm with the best price. However, "the product's time has come," says Reinhart. "One of the points of writing the paper was to get people talking about [the need for standards]. Demand [for separate accounts] is starting to build-it's what wealthy individuals are looking for."

Evaluating Performance In Separate Accounts

By Paul A. Kuppinger

Evaluating the performance of separate accounts is not an easy task. The reason? Simply put, mutual fund performance is straightforward and easy to calculate, and the reporting is standardized, while separate account returns may vary significantly from account to account. Plus, there is no set regulatory body governing the creation of separate account composite performance.

As we know, the net asset value, or NAV, is the price to purchase or sell a share of the fund. To calculate performance for any given period, one simply has to divide the current NAV by the beginning NAV (adjusted for distributions). By comparison, since a separate account portfolio is managed on a fully discretionary basis for each individual investor or institution, various factors come into play, and performance will vary between individual separate accounts.

For example, the following elements can cause similar portfolios to have different returns:

Contributions to, or withdrawals from, the account

Discrepancies in start dates

Investment philosophy of the manager

This discrepancy is termed "dispersion" and represents the standard deviation of the difference between the individual portfolios' returns. The composite performance, as reported by the manager, represents the average performance of all the individual accounts. This is important for you to know, as the question may arise with clients from time to time and your ability to articulate this is critical.

What Are The Rules?

The Association for Investment Management and Research (AIMR) determines the rules for calculating performance. AIMR, the professional organization of money-management organizations and retirement plan administrators, has developed globally accepted standards for reporting investment performance. While AIMR has extensive performance-reporting requirements, the three most important rules in calculating performance under AIMR standards are:

Each of the firm's discretionary fee-paying portfolios is in at least one performance composite.

The composite performance for a group of portfolios of similar styles represents the manager's reported performance for that style of investing.

Performance for each composite must be asset-weighted.

AIMR exists to ensure that firms record an accurate picture of the product's complete performance record. Without this requirement, there is a potential for firms to exclude poor-performing portfolios from the appropriate composites. This could give you an incomplete picture and cause you to inaccurately evaluate a manager.

Caveat Advisor

However, there are shortfalls to the AIMR requirements. You need to do additional analysis of the composite in order to assess whether historical returns are a reasonable depiction of the performance your client should expect. While firms must disclose all performance composites to a potential client if asked, they are not required to do so until that time.

The performance composite reported in marketing materials, Web sites and such performance databases as Mobius or Effron/PSN can be different and may address only one of many similar composites. In some cases, a manager will only report a composite of larger institutional accounts. These returns may be completely inappropriate for high-net-worth individuals.

Larger accounts also may distort returns in composites that include both institutional and high-net- worth accounts. For example, if a manager has 100 million-dollar accounts that returned 10% for the quarter and one $100 million-dollar account that returned 14% for the quarter, the asset-weighted composite performance would equal 12%. Under this scenario, if you had a million-dollar account, would you expect a 10% or 12% return for the period? The inclusion of both large institutional and smaller high-net-worth accounts distorts returns for the high-net-worth investor.

How The Analysis Is Done

In evaluating the composite returns of a private money manager, analysts consider what is represented in the composite returns. They first assess the percentage of the manager's portfolios and assets in the composite. Depending on which accounts are included, the ultimate reported performance would be influenced.

Additionally, the analyst assesses what types of assets were contributed to the composite performance in relation to their situation. Finally, the "reported dispersion" is analyzed, as well as the "expected dispersion," based on the composite construction. If the composite is constructed poorly, the reported dispersion is irrelevant.

To better illustrate this, following is a case study of three managers and the composites that they made available to major performance-reporting services. As can be seen, performance composites can be manipulated and must be studied to determine if they are adequately representative of the manager's performance history.

Manager A

The composite for this product includes 100% of all assets and 100% of all portfolios managed by the firm. However, the composite also includes both taxable and tax-exempt portfolios, which has the tendency to distort returns for the taxable investor. Furthermore, the composite includes substantial back-testing, which makes it non-AIMR compliant and possibly not representative of future individual portfolio performance. Portfolios are managed from a model portfolio, and as a result, dispersion should be minimal.

Manager B

The composite of the product is average in its representation of the performance of an individual portfolio. It contains approximately 95% of all assets managed in this style, but only 55% of the portfolios managed in this style, as well as portfolios with assets of $10 million or greater are included in the composite. It also contains taxable and tax-exempt portfolios, which can misrepresent performance for taxable investors. The composite has a low reported dispersion and is in compliance with AIMR Level II Performance Presentation Standards.

Manager C

The composite for this product is above average in its representation of the performance of an individual portfolio. The manager has separated the composite into three distinct composites based on target markets. There is an institutional, high-net-worth and broker- consultant composite. Dispersion for this product should be low because the majority of client portfolios are based on a model portfolio with limited turnover. Dispersion is low for wrap and institutional clients, but high for high-net-worth clients. The composite is in compliance with AIMR Level II Performance Presentation Standards.

It's A Wrap

As shown here, managers have great flexibility in creating and reporting their composite performance. Of the three managers, here's how they fared:

Only Manager C has a composite that truly is representative of performance for different types of clients.

Manager B's composite is AIMR-compliant, but its performance is not necessarily representative of the high-net-worth client.

Manager A's composite may not be representative of the high-net-worth client or future results.

To get a full understanding of the composite and its impact on individual clients, one cannot just accept the returns as reported by the manager but instead must dig deeper into the composite's construction.

Paul A. Kuppinger is director of research for Denver-based Prima Capital, a Web-based applications service provider dedicated to providing research, due diligence and systematic manager evaluations and rankings. Prima facilitates the selection of private-account and mutual fund managers who best suit the needs of high-net-worth investors.

Managing Risk In Separate Account Portfolios

Christopher Richey, CFA, is the director of the mutual fund portfolio group for Brandes Investment Partners LP, a global value manager in Del Mar, Calif. The firm manages more than $60 billion in assets. MAQ spoke with Richey about managing risk in Brandes' separate account portfolios, both on a short-term and a long-term basis.

MAQ: Chris, what kinds of portfolios do you manage at Brandes?

CR: We are an equity shop only, and we've built our reputation as a disciplined value manager. We manage several asset classes within the value style. We believe there is a limit to how much you can manage and still stick to your principles, so we shut down our international product (emerging markets, mid- and small-cap and Europe-only portfolios) to new clients in '98, and we just closed the global product at the end of November. Our U.S. value remains open.

MAQ: How do you manage risk on a short-term basis in a value portfolio?

CR: We generally have a three- to five-year time horizon, so we technically don't manage for short-term risk. We view short-term volatility in any particular holding, especially if it goes down, as an opportunity to buy more. For instance, we started buying Raytheon a couple of years ago at around $42. It got all the way down to the low $20s, so we have an average basis around the mid- $20s, and now, it's trading around $35.

MAQ: So, you have a dollar-cost-averaging strategy of sorts?

CR: Well, we believe in the concept of intrinsic value-having some idea of the long-term value of a company based on a three- to five-year holding period. We insist on a substantial discount between our intrinsic value estimate and our buy price. That's one way we manage risk. Another way is by looking for cleaner balance sheets. Having too much leverage in a company produces a lot of short-term risk because bankers have a right to come in and grab the company if it doesn't pay the debt.

MAQ: What are your strategies for managing risk on a longer-term basis?

CR: What we do is derived solely from Ben Graham's work. We basically manage risk in four ways, including the two I just mentioned. So one, we try to think long-term about the company so we don't get distracted by short-term events. Second, we buy at a significant discount to the intrinsic value. Third, we look for a clean balance sheet and fourth, we spend more time analyzing a company's history than its future. By looking at 10 to 20 years of the company's history, we get a very good idea of how the stock might react to what we consider short-term events. The combination of all those things gives us comfort that we are managing the overall risk well. So when the price goes down below our buy price, we're getting offered what we believe is the same good quality at a lower and lower price.

MAQ: How do customize your portfolios for individual investors?

CR: Our tax efficiency is handled by the fact that it's a three- to five-year investing time frame, so the turnover stays pretty low-anywhere from about 24% to 40%. By having good principles and applying them consistently, regardless of the circumstances, we've been able to deliver a 15.6% average 10-year performance in our U.S. Value composite.

MAQ: Thank-you for your insight.

Study Reveals Challenges, Solutions For The Industry

By Kevin Keefe

At this writing, total assets in separately managed accounts were growing faster than any other mainstream financial services product and were rapidly closing in on much more established retail financial services products such as variable annuities.

According to The Money Management Institute, the national organization for the separately managed account industry, industrywide assets in separately managed accounts approached $400 billion at the end of the first quarter of 2001. This figure represents 67% asset growth from 1997 year-end asset levels of $240 billion, and compares with 44% asset growth in the mutual fund industry over the same period.

A recent study, Best Practices in the Separately Managed Account Industry, by Financial Research Corp. shows the challenges, obstacles and solutions to running this type of business. In this segment of the study, we take a look at the business from the investment-management side. If you are an advisor doing SMA business or thinking about doing it, you'll want to increase your knowledge in all areas, including understanding what the money manager faces today in light of the explosive growth.

Capturing assets, due diligence, technology, staffing and revenue pressure are some of the challenges, but the solutions are either here, or imminent. Here are the top 10 findings taken from one chapter of the study:

1. SMA assets are a challenge to attract but much easier to retain. While the mutual fund industry continues to grapple with the challenge of average redemption rates of more than 30%, managed account sponsors have reported annual redemption rates as low as 8% to 10%. Being able to hold on to assets for an average of up to 10 years, versus roughly three years in the mutual fund world, gives separately managed account providers a huge advantage over their mutual fund brethren in the quest to grow assets.

2. The challenge to mutual funds is real. Intermediaries are diversifying their books to include a variety of alternative products, and name separately managed accounts as the No. 1 product they are considering for their clients going forward. The mutual fund industry will have its hands full battling SMAs for new assets. Particularly vulnerable are the $100,000-plus purchases of mutual funds and maybe even fund account balances in the $150,000 range and up. After more than 20 years of strong and virtually unchallenged growth for the fund industry, SMAs may present the greatest challenge to the continued growth and profitability of asset managers that remain wedded to funds alone, and many fund complexes are moving into this arena.

3. Fees for separate accounts have fallen, producing benefits and challenges. Total SMA fees used to be as high as 3%, but they have rapidly fallen to an average range of 1.8% to 2.0%. This has created much greater interest, but at the same time has placed significant revenue pressure on investment management firms. In an arena with significant hurdles before sustained profitability can be achieved, this downward pressure on fees is a primary concern expressed by many investment managers.

4. Margins will be reduced in the early years of an SMA initiative. Operating an SMA business as part of an overall investment-management firm initially will be a drag on firm margins. The traditional $100 million in asset profitability gauge, common in the fund world, simply does not apply here. SMA breakeven probably lies closer to $500 million, once the additional operation and distribution expenses are incorporated. The good news is that at $1 billion, an SMA business can achieve margins at or above the current levels seen in the investment-management industry as a whole.

5. Operational excellence is absolutely essential. We cannot stress enough the critical role that operations play in the successful execution of an SMA effort. Excellence in other areas simply cannot make up for meaningful deficiencies in operational capacity. Asset managers with top-notch performance should not deceive themselves into believing that sponsors will overlook their operational mediocrity just to have the honor of access to their outstanding performance. According to SMA investment managers of all sizes, the most significant challenge they face today is dealing with the operational realities of the business. More than two-thirds of the firms we surveyed listed operational issues as a top challenge. We cannot overstate the need for investment managers to have an operational platform that is flexible enough to cater to the unique needs of the various program sponsors. Because the demands of every SMA program are different, having an operations staff that is able to integrate multiple trading and accounting systems should be a primary goal of every investment manager.

6. Recruiting qualified professionals is a major challenge. After operations, the next most challenging aspect of the SMA business from an investment-manager's perspective is the task of finding, hiring, training and keeping qualified personnel. Distribution and operations personnel require unique skills that are not always immediately transferable for those with mutual fund or institutional experience. The industry also lacks the tools and data needed to plan for deploying sales teams and for staffing operations groups as businesses grow.

7. Investment managers should do their own due diligence on sponsor programs. SMA program sponsors have teams of individuals dedicated to evaluating (the investment) firm. Investment managers should develop a similar team of their own to carefully evaluate sponsor firms and programs to find the best fit for their organization before making the decision to join. The cost of participating in an ill-fitting program can be disastrous. Thorough homework is a must.

8. The SMA marketing process is very different from that for mutual funds. It is imperative to keep in mind at all times that it is a process, not a product. Intermediaries believe that if separately managed accounts are sold just like any other investment product, the client will typically only invest the minimum per account. However, if the intermediary does a good job of first establishing the need for the process in the client's overall portfolio and then presents a separately managed account program as the solution, the rep can gather a much greater share of the client's investable assets.

9. Maintaining dual books is expensive, but wise. The decision whether to maintain accurate duplicates of the records kept by the program sponsor will have significant implications on SMA business and possibly the entire investment-management operation. It profoundly affects the ability to create AIMR-compliant performance reports, track SEC compliance issues and accurately monitor sales and assets.

While the prospect of going through this extra effort may seem expensive, redundant and even unnecessary, we believe the benefits far outweigh the full costs of not keeping accurate books in-house.

10. Core investment disciplines dominate, but there is room for everyone. Large established investment managers will continue to dominate core SMA product offerings and will try to expand their reach by introducing additional varieties of core-management disciplines. However, small and midsize investment firms still have a great opportunity to make their initial splash in complementary investment disciplines. After gaining a following and establishing some momentum in less penetrated investment categories, they can then attempt to branch out into the more core disciplines, where can have a better chance of competing for business against their well-known and entrenched competitors.

Kevin Keefe, CFA, is vice president and senior consultant at Boston-based Financial Research Corp., a provider of competitive market research and analytic services to the financial services industry. For more information on this and other studies, contact him at (617) 557-3412.