At Their Service

Once investors reach millionaire status, they develop a completely different attitude toward their portfolios. Mutual funds are well and good for people who still have six-figure estates, but once they cross into millionairedom, they want products that befit their superior financial status. This is especially true for investors who work their way up into seven figures gradually and, in some cases,

Once investors reach millionaire status, they develop a completely different attitude toward their portfolios. Mutual funds are well and good for people who still have six-figure estates, but once they cross into millionairedom, they want products that befit their superior financial status.

This is especially true for investors who work their way up into seven figures gradually and, in some cases, unexpectedly. Often, they don't even consider themselves rich. We call these off-the-radar affluent investors, middle class millionaires (see the January 2002 issue of Registered Rep.). The favored product for the newly affluent — is the managed account. There are plenty of compelling reasons for wanting one: customization, tax efficiency and an all-inclusive fee.

In a survey of 329 of these hidden millionaires last year, we learned something else: Above all, these investors want access to money managers who would not otherwise be available to them. That answer tells us that these investors have a somewhat limited view of the real advantages of managed accounts. It also underscores the opportunity for you to win some of these clients by educating them about the more important benefits, including tax and estate planning.

The findings are based on a survey commissioned by Merrill Lynch and conducted by Prince & Associates. More than three-quarters of the respondents had from $1 million to $3 million in liquid assets that were not in a retirement account, while the remaining 21.7 percent had more than $3 million. Two-thirds of the middle class millionaires were men. With respect to age, they were evenly divided among those who were 45 to 55, 55 to 65 and over 65. The group included self-employed business owners, executives of publicly traded companies and professionals such as lawyers and doctors.

Their interest in upscale investments doesn't mean that mutual funds and managed accounts can't coexist. The former can continue to play an important and complementary role in any investor's portfolio.

In any case, we have found those affluent investors rely on financial advisors to help them put together a plan and select the right mix of products (though they often leave their old advisor behind for a new one who is more accustomed to dealing with wealthy clients). The interest in managed accounts as well as funds of funds and hedge funds is not just a question of cachet, though that's clearly a factor. The simple fact is that the more money involved, the more complicated the financial picture becomes, particularly from a tax standpoint.

While the numbers vary widely, Cerulli Associates estimates that the overall market for managed accounts reached $667.8 billion in the third quarter of 2001. It's worth noting that the managed account market is measured in different ways by different firms. For the purposes of both our research and Cerulli's study, the managed accounts business included separate account consultant programs, proprietary consultant programs, the rep as portfolio manager, fee-based brokerages and mutual fund advisory programs. Our research, however, does not include the important and often-overlooked group of advisors who sell managed accounts: trust companies, private banks and independent asset managers.

However, that total is still just a blip when compared with the nearly $7 trillion Americans have invested in mutual funds, the growth has been dramatic: The total was just $75 billion in 1994, Cerulli said. The rapid increase is both a testament to the rising wealth of Americans over the course of the last decade — there have never been as many millionaires as there are today — and to the growing interest among the affluent for customized financial solutions.

Most importantly, managed accounts, unlike mutual funds, are customized to meet each client's unique financial needs and specific tax issues. That's particularly important in the wake of a downturn like the one we're in now where many mutual fund investors faced losses in their portfolios but still had tax bills for realized capital gains.

Managed accounts offer other advantages. There is a single fee, the manager is directly accountable to the client and the investor retains control over the equities in the portfolio. For reps, managed accounts also have advantages, including this: Because of the individual attention involved in administering managed accounts, it is less likely that this form of investing will become an online commodity, like some mutual funds.

An insight and a misperception

Our middle class millionaires were insightful to latch onto another key advantage — access to smart money managers. Most of these money managers work exclusively with institutions, preferring to work with sophisticated and knowledgeable investors, using predetermined benchmarks and establishing high investment minimums.

However, our respondents were mistaken in thinking that having a high-octane money manager was the most important criterion when it came to a managed account. Middle class millionaires are wealthy enough to have a more complicated financial profile. For them, it is no longer a simple game of chasing maximum investment profits. Because of their more complex tax issues, the bigger issue becomes net returns, estate planning and tax avoidance. Indeed, as our research has shown, the more money people have, the more interested (one might even say obsessed) they become with tax-saving strategies.

Pure money making is fine for mutual fund managers who don't have to worry about the tax consequences of their success to individual investors, but such special, individualized attention is the very reason for a client to go with into a managed account to begin with. The goal of a managed account, in short, is not total return, but net results. It's not what clients have on hand at the end of a quarter, but what they have when they retire.

The ideal managed account manager does make money, of course, but he or she does so within the context of a specific financial plan. In addition, mutual fund managers are not paid to observe the social graces and curry favor with clients; for those firms that offer managed accounts, however, it's part of the job description.

The fact that our research shows that middle class millionaires want managed accounts provides an opportunity to capture new business. The fact that they want managed accounts so they can access top money managers provides an opportunity for education and connection. Learning that a managed account is about overall financial process rather than short-term performance is an important step for middle class millionaires as they come to terms with their affluence.

(Next month, we'll see how middle class millionaires feel about other higher-end financial products such as hedge funds and private equity funds.)

Writers' BIOS:
Hannah Shaw Grove
is a managing director at Merrill Lynch Investment Management.

Russ Alan Prince is president of Prince & Associates.

Why Middle Class Millionaires Want Managed Accounts

  • 91.1% liked managed accounts because they gave them access to otherwise unavailable money managers.

  • 38.7% liked managed accounts because of their tax efficiency.

  • 16.9% liked the fact that managed accounts have an asset-based fee structure.

  • 13.7% liked managed accounts because they had an all-inclusive fee structure.

Source: Merrill/Prince

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