Schwab, Fidelity and Waterhouse are building sophisticated SMA platforms.

In the independent advisory world, separately managed accounts (SMAs) are continuing to be big business. "Separate Account Consulting Programs," the Cerulli Associates' definition of SMAs using third-party manager programs or proprietary manager programs, gained assets at a rate of 3.67% over the three-month period ending September 2003.

In its managed account quarterly summary dated November 2003, Cerulli notes that for the 12 months ended September 30, assets in third-party manager programs grew at a pace of 24.3% compared with growth of 26.4% for all managed account programs, including mutual fund and nondiscretionary programs. Net cash flows, however, were 29% less than in third quarter 2002, which saw flows of $38.7 billion as opposed to 2003's third-quarter flows of $27.4 billion. Total managed account assets, including those in separate account consultant programs, mutual fund advisory programs, rep-as-portfolio manager programs, and fee-based brokerage programs, grew 5.1%, beating the Wilshire 5000's 3.7% rise in the third quarter.

Although the third-party manager programs saw an overall drop in asset levels for the year, third quarter 2003 garnered an impressive $12 billion in new assets. By far, the fastest growing independent third-party manager program sponsor is Charles Schwab, according to John Morris, newly appointed head of the managed accounts group at Charles Schwab & Co. "We're seeing incredible growth. The assets are just flowing in from advisors. We've grown from $9.6 billion at the beginning of the year with advisors to $12.7 billion-a rate of 33.7%."

No other third-party provider approaches Schwab's size in terms of either assets under management or breadth of its services platform. What's its secret? What makes its separate account programs different from the ones offered by Fidelity and TD Waterhouse-two other companies known for services they provide advisors?

The Schwab Edge

Being "first" has significant advantages. Schwab's first managed accounts program launched about five years ago. Fidelity's followed shortly after, and TD Waterhouse's program was initiated in 2000. Being early offers ideal positioning, which is definitely true in this case as Schwab ventured into SMAs with its Managed Account Connection, an open architecture platform that allowed advisors to choose from any number of money managers to implement their client's asset allocations and then custody those assets at Schwab.

"It was completely unbundled so the advisors could work with whomever they wanted," adds Morris. "The money manager would charge a fee and would negotiate that fee with the advisor. There also would be a Schwab fee for brokerage and services, then an advisor's fee, so it's truly open architecture with lots of flexibility and ease of implementation."

Being first also enables the largest and most rapid growth of assets. Today, Schwab boasts $11 billion in assets under management in separate accounts. Its two programs, Managed Accounts Marketplace (MAA) and Managed Account Select (MAS), provide access to outside money managers. MAS resides as part of the Managed Accounts Marketplace program.

Here's a brief description of both:

Managed Account Marketplace. The Marketplace program, from which Schwab's original Managed Account Connections grew, is the basic program for advisors wishing to use a fully open architecture platform for separate account business. To help advisors sort through the long list of money managers, Schwab has adopted within the program a Web-based tool using CheckFree's Mobius Group manager search database that it calls its Money Manager Analysis and Proposal System (MMAPS).

MMAPS enables advisors to do a search of managers, determine whom they want based on the criteria they use, create an asset allocation analysis and generate a customized program. Explains Morris, "We give them the tools they need to be able to sort through and make appropriate selections for the client. The program also can archive multiple proposals for any number of clients. MMAPS contains Managed Account Connections, which is basically a list of criteria for the advisor to use in searching for appropriate managers."

Managed Account Select. To facilitate the due diligence process, Schwab formed an alliance in 2001 with Callan Associates to provide its advisors with institutional-level research and review on money managers. "A lot of advisors came to us and said that even with the tools we had provided them, narrowing the list down to the managers they thought would be most appropriate was still a daunting task," Morris says. "This extra offering initiated the creation of our Manager Select program. Manager Select is the MMAPS program with some extra services such as access to the Callan research and the access to the investment managers. All account capabilities are delivered to the advisor client inclusive of fees. Advisors can pretty much design the program they want using the Manager Select program."

Advisors can subscribe to MMAPS if they don't mind doing the due diligence or other functions themselves. If advisors want help with the due diligence process and/or want the services of an outside registered investment advisor to assist them in determining the right investment policy and asset allocation for the client, Schwab provides access to a list of RIAs willing to work with them. Currently, about ten RIAs on the Schwab list for advisors are available to use as such a resource. Schwab is willing to add to the list when advisors request a specific RIA they'd like to use.

Sometimes, open architecture can be limited by the managers or resources included on a sponsor's list, but with its willingness to add managers advisors want, Schwab has created an objective way for advisors to serve their clients. These criteria have primarily to do with the ability of the management firm to function within Schwab's systems so that Schwab can maintain the high level of service it has established with its advisors, as opposed to meeting firm-wide due diligence standards for list inclusion. Thus, Schwab's program truly has been open architecture from inception. To date, approximately 500 managers are accessible through Schwab's platform, which is used by more than 5,400 advisors.

The Competition

Fidelity's platform offers approximately 135 managers and more than 360 investment styles and disciplines with about $6.3 billion in program assets; TD Waterhouse serves about 2,500 advisor clients with approximately $70 million in assets under management.

Fidelity provides a comprehensive platform offering custody, investment solutions, technology support and business-building support principally to RIAs and third-party administrators (TPAs). It serves about 2,200 RIAs and has approximately $100 billion in total custodied assets. Over the last several years, according to Gary Gallagher, senior vice president of product management, Fidelity has concentrated on building overall product capability, of which the separate account product has been a critical component.

And according to Tom O'Shea, Fidelity's vice president of managed accounts, they've partnered with a variety of third-party sponsors offering wrapped programs through their RIAs. "We also support RIAs who want to construct their own programs, and we have managed to garner about $4 billion in assets from the RIA group. In addition, our sister organization National Financial, which is a clearing broker-dealer for an introducing broker-dealer (Common-wealth Financial Network to Bank of America), [has] managed to garner another $2.3 billion. So, in both our RIA group and our clearing broker/dealer, we've got about $6.3 billion in the program." Surprisingly, Fidelity has no proprietary money managers or investment programs.

Many of its advisor clients hold the CIMA and/or CFA designations. "We're finding that advisors may have smaller books of business and have clients that feel more comfortable working through advisors," says Gary Gallagher. "Separate accounts will become an even more important part of the client's overall portfolio in the coming years. If you've got a $1.4 million average account size, then you have to bring in $6 million or $7 million in assets."

Fidelity divides their advisor clients into two groups-those who are willing and able to perform their own due diligence and set up their own programs, and others who want to work with an outside due diligence provider that has leveragable technology and wraps the fees together. Approximately nine months ago, Fidelity launched a new program called the Separate Account Network. "That's for advisors willing to perform their own due diligence and work directly with managers," explains O'Shea. "We're finding increasing numbers of advisors who want to do that as separate accounts become more popular."

The average account size of a Fidelity separate account client is $1.4 million. Its average client relationship is between $5 million and $7 million. "We've been able to attract the platform of true wealth managers dealing with ultra-high-net-worth individuals," adds O'Shea. "We've had this relationship with separate account managers for several years, and we're really focusing on simplifying things and adding more services."

At TD Waterhouse, the Managed Assets Network (MAN) was started to meet advisor demand for access to institutional separate account managers, according to Christopher Murtha, regional vice president of institutional services. "At that time, we had a list of 25 to 30 different managers with whom we had negotiated a pricing schedule," says Murtha. "The firms we solicited were recommended by our advisor clients. Over the last couple of years, as the separate account industry has grown, so have the original needs of our advisors expanded."

In finding a solution for that expansion of needs, Waterhouse decided to team up with third-party platform provider EnvestnetPMC. "We felt that partnering with EnvestnetPMC made the most sense because it fit into our philosophy of best-of-breed strategy," he adds. MAN was the original program offered by Waterhouse in 2000. Since the agreement with EnvestnetPMC, a new offering has been created called the Managed Assets Program (MAP).

MAP has two levels of service: Premier and Premier Plus. Says Murtha, "The Premier program is designed to work with advisors who already have a certain comfort level and sufficient working knowledge of separate accounts. The Premier program uses all the tools of EnvestnetPMC, but allows the advisor to do his or her own due diligence, proposal generation, asset allocation and ongoing monitoring. The Premier Plus program provides access to outsourced vendors, who offer manager search and research capabilities, as well as the same services Premier offers but on an integrated platform, which is actually EnvestnetPMC's platform privately labeled and fully customized by Waterhouse for its clients."

In the past, some advisors have felt that Schwab posed a competitive threat to its own clients by offering high-net-worth advisory services within its own ranks. According to advisor Harv Ames of Ames Planning Associates Inc. in Peterborough, N.H., "We've looked around for alternatives up until the last few years, because Schwab has been perceived by me and my peers as becoming increasingly competitive with us by offering advisor services in its branches. But recently, it seems Schwab has once again become advisor-friendly."

Ames claims that Schwab was the "big Kahuna" 11 years ago when he transitioned his practice to fee-only services. He decided to use Schwab because it offered the systems he needed and smooth operation of those systems. In the early days, Ames says Schwab also offered unparalleled service to its advisors.

After losing that focus, Ames says he became disheartened, but later Schwab began courting advisors in much the same way as before. Increased competition from the likes of TD Waterhouse and Fidelity may be one reason for a resumption of the good service. Ames believes another reason may have to do with the recent bear market. "They lost revenue on the trading side but they didn't lose much on the advisor side. Our part of the revenues went up, so they became more aware of the possibility of losing market share," adds Ames. "The higher market share you have, the higher your profitability. Lose market share and you lose not only the absolute profitability, but also the relative profitability."

Fee Structures-Then And Now

Not only was Schwab innovative in setting up the program initially, but its fee structure and completely open architecture business model was the first of its kind. The fees were unbundled and clients could see how much was being charged for what service.

With its Managed Accounts Select program, Schwab delivers Callan Associates research and review, the money manager's fee and all trading costs and services for one all-inclusive fee. So the client pays no more than 1% for this combined package of services, including the product fees. "We start at 1% and it goes down from there," Morris explains. "If it's a $1 million arrangement where the client has it all in Select, it would be delivered at 86 basis points. When you think about that, the advisor can then add 70 basis points on top of that, which would be 1.56% to the client, completely all in. That's extremely competitive as opposed to what's being offered through the wirehouses."

Morris also sees a lot of wirehouse advisor attrition down the road as a result of competition in the areas of fees and efficient service provision. "An advisor can make fees entirely neutral for the client and still be making, maybe, 70 to 80 basis points or more by simply being independent," he says. Wirehouse advisors tend to worry that they will have problems replacing the level of services provided them if they go independent, so Morris says Schwab concentrates on providing services in a way that enables advisors to implement their practices in a profitable manner.

TD Waterhouse says EnvestnetPMC is constructing a multiple style account that will allow the fees to be all-inclusive. Currently, clients pay a management fee to the advisor, the money management fees to the money managers and applicable product fees associated with the specific investment vehicles chosen. Waterhouse's program fees can be as high as100 basis points in the Premier program and 125 basis points in Premier Plus, neither of which includes the advisory fee covering custodial services, trade execution and clearing, the underlying sub-manager or the research and platform services of EnvestnetPMC. So the client pays one fee for the advisory services, one for product services and another for the management services.

Points Of Distinction

In comparing Schwab's offerings to Fidelity's and Waterhouse's, the first comment regards size. Schwab's massiveness and the length of time it has been addressing the separate account market give it a clear advantage in many ways. Some may say that Schwab has sacrificed service in the past in order trying to be all things to all advisors. But, according to many advisors, the service focus has changed for the better, and Schwab's offerings undoubtedly offer some advantages through size and experience in the separate account marketplace.

When comparing other providers with a powerhouse like Schwab, such things as advisory educational levels, service delivery, technological capability and ease of assimilation also come into play.

Waterhouse says it competes with Schwab from increased investment choices and a more integrated service platform. It offers a Web-based system called VEO through which advisors can access the MAP program Web site (which is really EnvestnetPMC's site customized for Waterhouse). "Advisors can create proposals there, print off the paperwork, deliver it to the client, have it sent back to us and we put it in the standard platform so the client or the advisor can download all the updated information on a daily basis," Murtha says.

Fidelity concentrates on the RIA market almost exclusively, working to offer it a broader wealth management strategy to complement the use of separate accounts. Its program offers functionality, support and products around a number of disciplines, including financial planning, trust services, separate accounts, alternative investments, corporate executive services and other securities. Holistic needs of wealth managers within the RIA community are a fundamental component.

Schwab concentrates, however, on providing advisors the complete ability to be an "overlay portfolio manager" and on offering a completely open product and service architecture, yet with outsourced professional services available and easily accessible.

Size can mean the difference in offering every capability that is realistically possible as opposed to only being able to cater to a few specialized groups. Schwab's structure can offer a great deal of flexibility to accommodate almost any type of advisory practice focus. They continue proving their viability through innovation and strength in the marketplace. Growth of assets under management, and the magnitude of their advisor alliance, is evidence enough.

Lisa Gray assisted with the research for this article.