Advances in technology make separately managed accounts available to smaller investors.
Whoever said that life is fair was probably not a
small investor. For years, they have watched the rich get richer, or at
least perceived it, as large institutions and high-net-worth
individuals participated in investment products that were unavailable
to them. Until recently, separately managed accounts (SMAs), for
example, had long been reserved for the "rich and famous," and anyone
with less than a seven-figure portfolio need not apply. Without access
to SMAs, some small investors assumed they were unable to invest with
the best-in-breed asset managers, and that they received fewer
customization and tax management benefits from their more traditional
mutual funds and exchange-traded funds (ETFs).
"To an investor who has only $25,000, that $25,000
is every bit as important to him as the investor with $10 million
dollars," says Scott Winters, national sales director for Platmark, an
affiliate of Eqis Capital, a managed account platform based in Oakbrook
Terrace, Ill. "He deserves the exact same type of options."
And finally they have them, or something close. "The
magic lies in technology," says Winters. "There are so many things in
this industry that once cost a lot of money from an administrative
standpoint. We've built out our technology in a way that we are able to
do things more efficiently. In fact, we have ways to customize our
smaller accounts. By putting socially responsible screens over the top
of an account, we can eliminate individual sectors or individual
alcohol or gaming or firearms stocks, for example."
Model Manager Approach
Others agree about the innovation in technology that
is helping the smaller investor. "We are now able to provide the same
level of asset management expertise-that same privileged access [to
SMAs]-to the mainstream investor with a $25,000 account," says Michael
Bell, CEO of Curian Capital LLC. "Through technological advancements,
we now offer one of the most efficient platforms in the industry, and
have streamlined the account opening process that once took at least a
week to now being handled in about ten minutes."
Bell adds that new technologies allow managed
account platforms to offer fully diversified portfolios with a far
lower entry point. His firm has incorporated a model manager approach
by contracting with the top asset management firms to receive their
portfolio buy/sell recommendations each day. Curian then trades these
managed accounts on behalf of investors and handles all of the
administrative details.
"This alternative approach allows sponsor firms like
Curian to structure and manage diversified portfolios using the same
intellectual property of the best-in-breed managers regardless of the
account size," Bell says. "The manager no longer has to deal with the
administrative aspects of account setup, custody, clearing or trade
execution, and is able to cut their fees by a significant degree.
Therefore, we can offer their same portfolios to smaller investors at a
lower cost."
For investors concerned that trading may suffer
using this model approach, Bell explains that the smaller account sizes
may actually lend themselves to faster and more efficient execution.
"Curian is a self-clearing broker-dealer that trades directly with the
Street," Bell says.
Hilary Fiorella, marketing and communications vice
president for CheckFree Investment Services, also acknowledges that the
model manager approach will allow smaller investors access to the best
asset managers. She believes that managed accounts will be opened up to
more small investors as brokerage giant Merrill Lynch begins
championing this approach through its Consults platform. "Merrill asked
their stable of managers to share their models-hand over the secret
sauce, so to speak," explains Fiorella. "They [Merrill] actually run
the portfolios and pay the managers lower fees since they do not incur
the operational obligations."
She adds that Merrill has been instrumental in
including more quality managers across various assets classes in its
platform, and that she believes the average minimum portfolio size
stands at about $100,000. "Today, small investors can get access to the
portfolios of good managers with good track records and good
diversification," Fiorella explains. "For example, using the
models-only approach, the advisor can access the portfolios of four
managers and place $25,000 within each. Therefore, somewhere around
$100,000 can get them the same quality investment advice as would have
once required a $1 million investment."
Fiorella believes that if Merrill Lynch's
models-only program proves successful, it will lead to more sponsors
following suit and offering similar models-only platforms. "Because
sponsors are in charge of distribution, they set the fees," she says.
"Other firms will likely come out with models-only programs, if Merrill
is successful, that will drive the minimums down and bring more
separate accounts to retail investors. However, some managers will not
hand over their models and will continue to manage their
trades/portfolios. Sponsors drive how the industry goes. It will be
interesting to see how the landscape changes over the next few years."
Steve Winks, publisher of Senior Consultant news
journal, views the enhanced fiduciary ability of the advisor to act in
the client's best interest as a primary benefit of this trend within
managed accounts. He believes the model-managed approach helps advisors
construct a more favorable value proposition for the client. "The
models-based portfolios help reduce the investment minimums,
democratize access to professional management, streamline costs
structures and allow advisors more direct knowledge and access to all
client holdings, something that is not possible with mutual funds,"
Winks says. "Firms like Merrill may not have acknowledged the fiduciary
status of its advisors, but they do see the economic advantages of
adopting this technology and approach."
Winks feels today's fee-based focus is very
conducive to the use of models. Because advisors incorporate the cost
of the investment vehicle into the total cost of their advisory
services, significant savings can be passed on to the consumer. Even
so, advisors can still enhance their compensation. "Through the models
approach, many of the redundant account administration costs can be
eliminated. Whereas a mutual fund costs consumers about 150 basis
points, not including trade execution costs, they could get managed
accounts for less than 50 basis points, models for 25 basis points or
less, for pretty much the same thing. In fact, the product is actually
superior because it is more style pure," Winks claims. "Now, by buying
real-time manager research [model portfolios], advisors and their
clients have all the benefits of the intellectual capital of the
manager without any of the detriments of being tied to the inefficient
operational structure of the manager. Through model portfolios, those
manager costs now have been cut in half or more. This creates a far
more efficient way to manage money and construct portfolios."
Customization Is Key
Dennis Clark, CEO of Advisor Partners, sees
interesting opportunities for smaller investors using managed accounts.
He acknowledges that sponsors can implement model portfolios with lower
minimums, though with very little tax management and customization.
Clark believes that to achieve the true benefits of SMAs, small
investors should turn to an indexing approach and hire one portfolio
manager (like Advisor Partners) to structure and manage a global
portfolio across all style boxes and market capitalizations. "Indexing
has become more appealing to not just smaller investors, but to all
investors," Clark says. "If you believe that some or all of the markets
are efficient, then indexing makes sense."
While Advisor Partners models portfolios to track
S&P 1500 and S&P ADR indexes, for example, Clark feels that it
is difficult for investors, regardless of their size, to get
customization in a packaged product like an ETF or index fund. "We
recognize that many investors have substantial customization needs,"
Clark says. "They may own a collection of stocks with low cost basis
and are concerned about tax issues. They may hold a concentrated
position or options in one company--their employer, perhaps-and desire
a portfolio that avoids that position and stocks that are highly
correlated."
With regard to smaller investors, Clark adds, "We
can structure custom portfolios or build them around current holdings,
and the benefits can be implemented among accounts as small as
$250,000. If that same investor wanted diversification among multiple
managers, the pieces of the pie would be cut up pretty small. Plus, it
would be highly unlikely they would ever get access to the lead
managers."
Curian's Bell points out that small investors can
receive the same customization and tax management benefits of SMAs when
using the model-manager approach. "It is as easy as checking a box or
two when setting up the account to create a custom portfolio." He says
that too few investors take advantage of these fundamental
characteristics of managed accounts, though Curian promotes them as a
way to differentiate itself. "While the adoption rate of these
customization features is about 5%, about one in three of our clients
customize."
Eqis' Winters agrees that the innovations in
technology allow small investors to receive the true benefits of SMAs,
including customization. Winters also stresses the cost advantages of
the platform Eqis Capital has developed through the latest innovations
in technology. "When I say platform fee, I'm talking about custody,
clearing, commission, the money manager's cost, reporting, feeing - all
those different things that go into a platform. It's generally around
$1.40, $1.50," Winters says. "At Eqis Capital, we've actually torn down
those barriers once again, and we've broken the dollar, we've broken
the buck, we've brought our entry level account down to 95 basis
points, all inclusive." Winters continues, "In fact, we built a full
working CRM [client relationship management system] for advisors, all
within our platform, and we give it to them for free."
A Dissenting View
Not all financial services professionals agree that
SMAs are necessarily appropriate for smaller investors. Scott Tiras, a
Houston-based advisor who manages the top producing practice at
Ameriprise Financial, uses managed accounts for some of his larger
clients. However, he believes that investors must have at least
$500,000 to $1 million within their portfolios to reap the full
benefits. "I understand the advantages of SMAs, but simply don't
believe they are that beneficial for most smaller investors," says
Tiras. "In some cases, they merely have become a compelling story for
the advisors to tell and play off the ego of investors who love
participating in institutional-like strategies."
Tiras doesn't believe small investors are able to
access the best managers, and most don't have the customization or tax
management needs that make SMAs so attractive to high-net-worth
investors and larger institutions. He also believes that changing
managers can become a logistical nightmare requiring numerous
individual transactions and some overlay component. "Many of the
best-in-breed managers are still not participating in wrap programs,"
Tiras claims. "In fact, most of them also manage mutual funds that
maintain very similar strategies and underlying portfolios as the
separate accounts. Further, while minimum required balances might have
declined for large-cap managers, more specialty classes like global
bonds, high yield and small cap still require sizable investments that
prevent the small investor from participating. Therefore, they are
limited in being able to fully diversify."
Regarding the model approach, Tiras sees some merit,
but believes that trade execution can prove quite significant in
certain less-liquid markets, like specialty fixed income and small cap.
"The investor could miss out on performance potential by taking the
experienced manager out of the trading equation."
For small investors and many of his large investors
as well, Tiras builds portfolios of mutual funds and ETFs. He points
out the ease and flexibility involved in buying and selling mutual
funds and the numerous good options across the various styles,
including the less-liquid asset classes.
"Mutual funds allow the small investor to achieve
greater diversification than SMAs for a less significant investment,"
Tiras adds. "The associated costs have been declining as well.
Recently, I read that mutual fund expenses are at an all-time low
level. And for those investors who prefer indexing and do not have
customization needs, you cannot beat the efficiencies of ETFs."
Like it or not, agree or disagree, SMAs are fast
becoming more of an option for the smaller investor. "The growth curve
is significant," says Curian's Bell. "The annual growth rate has been
in the 30% range over the past five years and is expected to be 15%
over the next five." CheckFree's Fiorella adds, "Sponsors drive how the
industry goes. It will be interesting to see how the landscape changes
over the next few years."
Interesting indeed. But, for now, life in the
financial lane has become a little fairer for the small
investor.