A roundtable discussion with leading advisors on the value of MDPs.

Multiple-Discipline Products (MDPs) continue to flourish-their share of SMA asset inflows has tripled since year-end 2000. Boston-based Financial Research Corp. projects MDP sales to represent 25% of all SMA sales, growing to approximately $35 billion by the end of this year and $46 billion in 2004. According to a new study, MDPs will capture 17% of the managed account market by 2004. Pioneered by industry giant Smith Barney/Citigroup and trademarked by them as Multi-Discipline Accounts (MDA) they offer advisors a solution for middle-market clients. Because almost all brokerage firms and many independents are offering some type of proprietary multi-managed account, the acronyms look like alphabet soup: DSP, MSP, MAP, MSA and MMM to name a handful.

Basically, multi-discipline products are model portfolios that incorporate several different style managers into one account. The advisor gets one statement, one performance report, and access to the Overlay Portfolio Manager (OPM), who oversees the asset allocation, rebalancing and monitoring of the portfolio. They are purported to improve advisor efficiency, open middle markets that might not be appropriate for a separate account (clients with $50,000 to $300,000 of investable assets), and reduce risk (more styles), while providing more time for client service as the investment management is outsourced.

That being said, industry sources suggest that advisors with assets of $100 million and more showed very little interest in this platform. FA talked to five successful independent advisors about their thoughts on this burgeoning market. They are:

Thomas A. Muldowney, CFP, CLU, ChFC, MSFS, managing director, Savant Capital Management Inc, Rockford, Ill.

George Strickland, CFP, CPA, CIMC, principal, Financial Synergies Wealth Advisors, Houston, Texas

Wayne von Borstel, CFP, CLU, ChFC, MSFS, von Borstel & Associates, Oregon Trail Financial Services Inc., Portland, Ore.

Lewis J. Walker, CFP, CIMC, CRC, Walker Capital Management Corp., Walker Capital Advisory Services Inc., Norcross, Ga.

John Yetman, principal, Goddard & Yetman Retirement Investment Group, senior vice president-investments/investment officer, Private Client Group, Wachovia Securities, Washington, D.C.

FA: Gentlemen, multiple-discipline products (MDPs) are hailed as being a perfect investment solution for middle-market investors, since many don't meet minimum requirements for a separate account. Would you agree?

Walker: There is no such thing as a "perfect" investment. At the low end, $50,000 up to $150,000, a diversified portfolio of mutual funds may be a better bet. I am more comfortable with MDPs at $250,000 or more.

Muldowney: I agree with Lewis. MDPs can be part of a solution, but are they perfect? No. Allocation strategies are already present as solutions for the middle market. Since the introduction of no-load mutual funds, the mutual fund itself has become a commodity. Interestingly, the part that has not changed is the role of the professional salesperson, who still gets paid for delivering investments to amateur buyers. Usually these products can be acquired for free via no-load vehicles.

von Borstel: Those are good points, but as with any investment, they've got some very attractive features but aren't without a couple of drawbacks. Generally, they don't contemplate all 22 asset classes. In building a model, they tend to be based on the more simplified stocks-bonds-cash platform. Real estate and futures/commodities are usually left out of MDP asset-allocation models. Those are beneficial asset classes I like to build into portfolios of $70k or better.

Strickland: Well, I am not convinced that MDPs are the perfect solution, either. It depends upon the quality of the managers within the program. Like SMAs, you limit your choice of managers to those who wish to participate in those programs. The difference is that with SMAs you can choose your managers and add mutual funds where a particular sector is poorly represented by the choice of managers. This is not an option with MDPs.

FA: We hear that MDPs reduce the client's risk profile by diversifying within managers instead of just having one manager with one style. Any other way to accomplish this?

von Borstel: This same scenario can be executed using mutual funds. In fact, you can have more choices of which asset classes to include in the portfolio for even greater diversification. The counter argument is one of cost. But greater diversification, choices and flexibility have to be worth something in that equation.

Walker: I would use an "overlay manager" to coordinate the buys and sells, and manage tax considerations, while using other "best of breed" managers to provide the stock and/or bond recommendations for each style segment.

Yetman: As we all know, there are many ways to lower risk in a client's portfolio. I assume we are talking about market or volatility risk, which is reduced by diversification of any kind. It is true, however, that if you want to have the fee-based, separate account environment and you have only $300,000, then the MDA approach will help you lower the clients risk by enabling them to own more asset classes.

Muldowney: Even if the investor deposited funds into separate and randomly selected index funds, the total portfolio risk would be reduced. The MDP and the allocation strategist ostensibly helps by measuring the risk, being conscious of costs, creating efficiencies and helping set reasonable investor expectations.

FA: It improves efficiency-i.e. paperwork, dealing with just one OPM instead of multiple separate managers. Agree?

Strickland: It is certainly fewer headaches for the advisor and, to a degree, the client who would prefer not receiving excess paper work, statements and tax information.

Yetman: I agree. In an MDP-type account you have one contract, one 1099, one quarterly performance report and one fee-so basically you have one brokerage account.

Muldowney: I agree with George and John. However, attention must be given by the investor as to the cost of the services provided both by the OPM and the underlying investment provider [i.e. the index fund or the costs of the active manager.] This typically also includes the portfolio efficiency and end-of-year tax reporting. Keep in mind that the word "efficiency" means that there is optimal return provided with the least amount of necessary investment risk.

von Borstel: For clients to whom simplicity is paramount, this platform's appeal is clear. One of the challenges I face in setting up complex portfolios with deep diversification and nontraditional asset classes for clients is that they get overwhelmed by how complicated it becomes and the mountain of paperwork required to get it implemented.

FA: Do you think MDPs minimize the advisor's value because most of the work is outsourced? Lockwood President Len Reinhart says if you're not giving advice or making investment decisions, what are you doing? What is your point of view?

Strickland: I would agree with his point. They are the perfect product for Schwab, TD Waterhouse and other non-advisor distribution entities. It is similar to the problem encountered with one-step products [SEI, Russell, etc.] What are you paying an advisor for?

Walker: Yes, but it depends on how the advisor is adding value in the client relationship. If the role is classic investment management consulting, yes, value may be diminished. The firm offering the MDP, like a Lockwood, will specify the asset allocation, pick the managers and rebalance. However, where advice is holistic as part of an overall financial planning process, and where investment management is a sub-function of financial planning, there is no problem. The MDP can free the advisor to concentrate on other aspects of the planning process.

Muldowney: I feel Reinhart's statement misses the point. The advisor's real job is always challenging and deserving of reasonable compensation. Advisors are continually "talking people off the ledge." The investor was ready to "jump" with both feet, heavier and heavier into stock positions in the late '90s. Now they are standing on the ledge trying to make two jumps! One completely out of stocks and the second jump completely into bonds. The job that is threatened is that of the investment manager. He sets out his own job description, then fails to meet it. His typical goal is to "pick good stocks," which by definition simply means better than average. Better than average simply means better than the index. And the managers have not done so well here; the indexes constantly and routinely outperform the managers, and they do so with less cost and with less tax exposure.

Yetman: I disagree with Reinhart's statement-the MDPs put us, as the advisors, in a consulting position, on the same side of the table as the client. The advisor can select from a pre-set model. At our firm [Wachovia] we have ten to 15 models already set up. Our other option, in line with the normal consulting approach, is we can tailor the portfolio. We can select from 17 managers and how much money goes to each manager.

von Borstel: It's a scary road, though. I have a tough time justifying why I'm getting paid to hire someone else to do all the work. There's a danger that we're commoditizing what we do, and we have to be careful about that in our business.

FA: Other comments?

von Borstel: Pretty soon, the MDP platform looks like a lazy man's way to consulting. How much value do we really add and does this approach encourage us to maintain a healthy, consistent level of fiduciary communication with our clients? Actively managing the client's portfolio forces us, if we're doing it right, to know our clients better, to be more involved, to be more aware and more in tune with what's going on. In the long term, I think that's a clearer path to better results and happier clients.

Walker: I agree. An MDP is a tool, and a tool used properly is a plus. But even a good tool, used inappropriately, is a negative. An MDP seen as a shortcut, or just a new product to sell, is likely to end up as a disservice to the client.

FA: A survey by Financial Research Corp. stated that most advisors with more than $100 million under management enjoy the consulting process, and they feel MDPs take them out of the loop. What are your thoughts?

von Borstel: I would agree with that statement. I give better value to clients because I do invest lots of time communicating about the nitty-gritty with people-asking the tough questions, listening to what they need, dealing with their assets as to how much can work, and what their real risk tolerance is, and so on. The underlying danger in over- systematizing what we do is that it tends to lead to less client interaction. As a macro-planner, I'm an expectation, risk and relationship manager-not an asset manager. We have to continue doing the fiduciary due diligence to ensure that we're investing for the client's reasons and not because it's easy or systematic for us to do it a certain way. There's a danger in trying to make investing so simple all the time. "Simple" is not necessarily the best value. Just like "cheap" is not the best value.

Strickland: I do not think that MDPs will be the choice of product delivery for higher-end advisors for many of the reasons Wayne just stated. It may be the product of choice, though, for those advisors who have chosen not to develop their consultative skills and wish to keep their overhead low and concentrate on marketing.

Muldowney: Not to be a contrarian, but MDPs do not take the advisor out of the loop unless the advisor thinks that his or her job is analyzing stocks or funds that have already been analyzed. The advisor is supposed to assemble the allocation components into portfolios that actually work to meet client goals and expectations. This is extremely rewarding.

FA: Ron Surz, president of PPCA, a performance attribution firm, was quoted as saying, "MDPs are like trains leaving the station without any brakes." I think he meant that MDPs have the potential of exposing clients to such risks as style drift. Do you see this as a possible problem?

Muldowney: The goal of any good administrator is to keep the trains running and to do so on time. The potential to style drift is always present. Ron's comments are keen and insightful. Asset style drift is a problem anytime something is placed on auto pilot, whether it is a mutual fund or an MDP product. Just as with cruise control in our automobiles, you do not leave it unattended. Allocation strategies are established with a narrow range of tolerances specifically to avoid asset style drift. Allocation strategists monitor the standing asset allocation in each client portfolio on a regular basis and execute rebalance transactions to bring the client portfolio back into the intended asset allocation.

Yetman: Style drift is always an issue when choosing managers within an asset allocation program. In most MDP programs, the brokerage firm is using proprietary managers. In that case there may not be any other choice, nor is there monetary incentive to eliminate managers that style drift.

Strickland: But it depends upon the diligence of the MDP provider, since the advisor will have not control over manager selection.

Walker: I agree with George. For example, if the sponsoring firm, like a Lockwood, does their job, there should be no style drift within the MDP. However, where MDPs are peddled as all-purpose solutions, you could see style drift in the client's overall portfolio if the advisor is not watching other pools of money outside of the MDP. But this has been a problem all along where separate accounts are only part of the overall portfolio that contains other "buckets" of money, like 401(k)s or other retirement plans.

von Borstel: Some MDPs may run this risk if they follow the "what's hot" model. But this is a fundamental design and oversight question for the sponsor. There are OPMs or liaisons (SEI as an example) whose value centers on micromanaging the risks of security overlap and style drift throughout the entire portfolio.

FA: Can using an MDP lead to mediocre management? MDPs don't necessarily give clients best-of-breed managers. Instead, they offer a multi-manager product from one sponsor. Your comments?

Strickland: Absolutely, look at the history of similar product offerings using mutual funds; they often end up being private high-cost index funds.

Yetman: Most of the MDP programs are structured in this format. Meaning that the managers have an affiliation with the brokerage firm that they work with. In that case this may lead to mediocre management due to conflicts of interest. All MDPs are not created equal.

Walker: I can see this happening if the one-sponsor product is used strictly as a device to push their managers. Look at mutual fund families. Often, a few standout managers are surrounded by mediocre managers. The best-of-breed concept has more appeal as long as the advisor has confidence in the research and monitoring abilities of the sponsor.

Muldowney: All very important observations, but here is where I'd like to point out another substantial difference between the MDP and the allocation strategist. It is a fair question for the client to ask, "For whom does the investment manager work?" [From which source does the manager derive his income?] If the MDP is truly independent and is truly working for the advisory client, then he has little choice but to focus on things that work. This is where the separation of the MDP from the allocation strategist becomes clear. The MDP is in the perpetual search for the provider who did good last year in the expectation that he will do good next year, too. The problem is that the investment environment is so dynamic that what may have been perceived as management "skill" shown from last year cannot be distinguished from "luck." Luck rarely repeats itself, so the MDP has to constantly make changes to the managers. This is costly, tax-nasty and unproductive. The allocation strategist never has to worry about asset style drift within an [index] fund. The allocation strategist has knowledge that costs are low, turnover is minimized and that luck is not a factor. The simple commodity-index fund-actually delivers the desired asset class. The allocation strategist then has the powerful duty of attending to the client needs.

von Borstel: We all know there's a flexibility trade-off in this type of platform when it comes to manager selection. You can't go in there and surgically remove one of the four large-value managers but keep the rest of the portfolio intact. That an independent [stand-alone] portfolio can avoid this is comforting from a flexibility aspect, but it's not a guarantee of manager superiority. However, an active stand-alone platform gives me more reasons to communicate with my clients and ensure that their goals and implementation are aligned.

FA: Are mutual funds, instead, best suited for the middle market?

Muldowney: Yes, the index funds. Keep in mind that both the allocation strategist and the MDP must provide results that are in excess of what the investor can do on his/her own. Consequently, the allocation strategist does have substantial investment selection responsibilities, which must be balanced with the other objectives of low cost, diversification, low tax exposure and meeting client goals.

Strickland: In my opinion, mutual funds are the better alternative for most investors. But on the other hand, it may be the better alternative for smaller investors whose assets are not too attractive to larger advisors. It is a better option for the do-it-yourself-investor.

Yetman: Separate account management and mutual funds used to be for different clientele. Now that account minimums are lower, many clients can obtain adequate diversification using separate accounts. Some clients prefer to own funds that they can follow in the paper. My clients also like the fact that there is more information available on mutual funds than with separate accounts. My opinion is that since most of my clients meet the minimum for proper diversification under either approach, I want the best money manager in each asset class regardless of whether they are a mutual fund manager or a separate account manager.

von Borstel: That makes sense, John. The fact is the less money you have to work with, the more attractive an MDA-type product becomes. It's virtually impossible to do what I would want to do for a client's ideal asset allocation [combining individual funds and direct investments] if they have less than $60k. And even if I could, the relative cost of periodically rebalancing that portfolio would rob most of the performance I'm trying to harvest. In the current environment, between about $60k and $100k, it's almost a toss-up according to the client's "simplicity tolerance." After that, notwithstanding the client's need for simplicity, I'm convinced I can add value combining traditional and alternative investments, or at least building a core portfolio that way and adding an MDA-type platform for some piece of the overall portfolio.

FA: An MDP can cause problems with the portfolios if one manager consistently underperforms. You can't replace your underperformer. Comments?

von Borstel: Probably there are two arguments here-the obvious one would support your assertion. But first you'd have to define what you mean by "consistently." You have to be careful about that. Is it one quarter, three quarters, one, two or three years? Even within a given asset class, say Large Value, a given manager's style approach will fall in and out of favor-maybe even for years at a time. And, if we're true to MPT, we don't want him to style drift just to "create" Alpha. If we answer the consistency question incorrectly, we'd almost constantly be replacing managers for one reason or another. If you believe asset allocation's role in MPT, at some level, you have to conclude that the relative performance of similar investments is not what brings-or fails to bring-you wealth. And, if that's true at the investment level, then it logically follows that it is true at the manager level.

Muldowney: The underperforming aspect is a keen observation and one that will not be advertised by the MDP-this is another area where the allocation strategist shows superiority.

Walker: One solution is to lean on the sponsor to replace the underperforming manager. If unremedied, and underperformance persisted, the sponsor who deals with independent advisors would lose credibility and, ultimately, the advisor as a client.

FA: Do you agree with the argument that MDPs help transition more easily to fees those advisors who still do some commission work? They really don't have to understand the consulting process; it is already done for them. Is this just an easy way out?

Walker: There is some danger that MDPs could become "separately managed accounts on training wheels" for advisors who want to provide a hot new idea. The advisor needs to understand the consulting process so that he or she can then understand what is behind the MDP. The advisor has to do due diligence on the provider and understand "the moving parts" of the MDP. How else will the product be properly matched with client goals and objectives and expectations? This is especially important where a provider offers a variety of MDPs designed to fit client risk tolerances and objectives.

Muldowney: I agree with Lewis, and I do not think that this is a transitional tool. While it may work in the field of sales, it is a grossly unfair implication that the professional advisor does not have to understand the consulting process.

The consulting process is of immense importance because it is client-centric. The raw delivery of a product [like the stand-alone MDP] does not solve client problems, set client goals or establish client expectations. As such, it is unreasonable to expect that the MDP will deliver a 30-year retirement, or put a child through college or pay for a wedding. When an investment is a stand-alone product, it is understandable that it would have to be sold, especially to unsuspecting or undiscriminating investors-it's just a weaker form of Lotto.

von Borstel: Well said, Tom. If it isn't an outright easy way out, it certainly paves the way to being one. I think some advisors are looking for a way that they really don't have to invest the time and effort in the consultation and decision process for clients-the guts of what this profession is really all about. The current fiduciary liability atmosphere only serves to exaggerate that tendency. It's a lot easier to blame the sponsor of an MDP who's running the entire portfolio, right? That being said, some clients who have a large enough portfolio and can perceive the potential benefit of having an MDA-type platform integrated into the rest of what we're doing, I find using it for about one-third of their portfolio can make sense.

FA: Thank you, gentlemen, for sharing your insight.