Free Yourself from the Research Grind

Finding the right mutual fund is no easy task. Advisors must screen through more than 11,000 choices. Then the best funds must be analyzed for their suitability in client portfolios. All too often the work must be redone when managers quit or funds are merged out of existence. Isn't there an easier way to steer through the mutual fund maze? Yes, says Michael McCabe, vice president of Kohlhepp Investment

Finding the right mutual fund is no easy task. Advisors must screen through more than 11,000 choices. Then the best funds must be analyzed for their suitability in client portfolios. All too often the work must be redone when managers quit or funds are merged out of existence.

Isn't there an easier way to steer through the mutual fund maze? Yes, says Michael McCabe, vice president of Kohlhepp Investment Advisors, a registered investment advisor in West Chester, Pa. In recent months, McCabe has turned over much of the heavy lifting to Morningstar Investment Services, a unit of the Chicago fund tracker. “We're capitalizing on Morningstar's research, and we're spending more time working directly with existing clients and reaching out to new clients,” says McCabe.

While pension plans have long embraced the concept, multimanagement is now taking hold among retail advisors. (In the separate account world, these are often referred to as multi-disciplinary accounts). Multimanager products — whether funds or IMAs — are one of the fastest growing subsectors in the asset management business, according to Cerulli Associates; multimanager assets under management total $489 billion globally, and the figure has been growing at an annual rate of 15 percent, Cerulli says. In contrast, mutual fund assets have stagnated. Frank Russell Company, the well-known pension fund consultant, is the largest player, with more than $200 billion and a 26 percent market share, Cerulli says. SEI Investments and Vanquard also are established players, and Morningstar is a notable entry into the sector.

Advisors say that such funds allow them to offer clients a convenient diversified investment while piggy-backing off of established institutional research. “You can either be an asset manager or an asset gatherer,” says McCabe. “It's hard to be both. This allows us to focus on the client relationship and doing the financial plan.” Moreover, institutional consultancies, such as Frank Russell, have tremendous access to the asset managers — access that financial advisors don't have.

It seems to work. In an era when nearly every category of equity funds is in the red, multimanagers have been performing relatively well, helped by big bond positions. During the past three years, some fund of funds — such as Vanguard Star and Smith Barney Allocation Income A — have managed to eke out gains. The entire fund of funds category, which includes many balanced multimanagers, has lost 6.4 percent annually during the past three years, more than 7 percentage points ahead of the Standard & Poor's 500 stock index, according to Morningstar.

In typical programs run by Morningstar, Frank Russell and other managers, advisors begin by filling out questionnaires that describe a client's risk profile and investment goals. Based on that information, the multimanager provider recommends a model portfolio ranging from conservative to aggressive. Frank Russell typically selects six to eight style categories for each portfolio, and assets in each category are divided among several managers. For example, Russell's moderate strategy portfolio has 33 percent of assets in short-term bonds, 9 percent in international securities, 11 percent in diversified domestic equities and the rest in a broad collection of stocks and bonds. The aim is to provide advisors with diversified portfolios overseen by top managers.

At Russell and some other providers, large clients can request more customized portfolios. But most clients must rely on off-the-rack choices. Once clients put money into a portfolio, multimanagers continuously monitor the assets, firing managers when necessary. “Russell keeps a close eye on managers to make sure that they are following a consistent strategy,” says Sherri Stephens, president of Stephens and Winton, a registered advisor affiliated with Raymond James in Flint, Mich., who uses Russell for some of her clients. “When you use mutual funds, you often don't know about a change in managers or styles until you have already run into problems.”

Even where they do not offer a perfect solution, multimanager programs can help advisors cut down on research time. After signing up with Russell recently, Dan Kiley made special efforts to plan his use of the time that had become free. Kiley, who is president of Retirement Capital Advisors, a registered investment advisor in Cincinnati, increased the number of face-to-face meeting with many clients from two a year to four. And he began holding monthly conference calls where clients could phone and ask questions about current market developments.

But McCabe, who uses Morningstar's service, cautions that advisors can't stop monitoring manager selections altogether. Even when Morningstar does the picking, he feels obligated to audit each choice and be able to explain each fund's strategy to clients. Plus, not all clients fit the model portfolios. Recently a client requested one with a sizable stake in real estate, so McCabe designed such a program.

In the past, McCabe charged fund clients an annual fee of 1.5 percentage points. Clients still face the same costs, but Morningstar keeps 40 basis points. That leaves less for McCabe, but he does not believe the extra tab will erode profit margins. “Is it worth it? I'm generating almost a third less, but our costs have come down because we're not spending as much time doing research,” he says. “Over time, revenues should increase because we'll have more clients.”

Last year, the multimanagers received a boost when the Department of Labor ruled that 401(k) plan providers can offer advice to participants. Thanks to the ruling, Merrill Lynch and SunAmerica are now rolling out multimanager plans. Under these programs, brokers call participants and offer to provide packaged portfolios. Clients who agree to join the program answer questions on the phone. The data goes to a system run by Ibbotson Associates, which determines the best combination of funds available from the choices in the 401(k) plan.

In the past, the government prevented providers such as Merrill Lynch from offering advice, fearing conflicts of interest. The new ruling says that brokers can deliver advice, provided the opinions come from independent third parties, such as Ibbotson.

For multimanagers, the stakes in the 401(k) business are enormous. Any player who cracks the huge market could reap a fortune. Just as important, multimanagers could help many plan participants build diversified portfolios that will bounce back from the market downturns and enable millions of savers to achieve their long-term goals.

Leaders of the Multi-Pack

Multi-manager programs ranked by share of the $260 billion market.

Manager of Managers Market Share
Frank Russell 26%
SEI 23
Vanguard 21
Northern Trust 6
Morningstar 0.5
Source: Cerulli Associates, individual firms.
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