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.